-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, HSGuvtb46t3KhevAyPyDO02uvuebeKstqMV8FNLAjIvMvGO9FCuRayilsLAtupgj 2GPpOUvlmketyMIIcQ4hsw== 0000038777-04-000348.txt : 20040514 0000038777-04-000348.hdr.sgml : 20040514 20040514171307 ACCESSION NUMBER: 0000038777-04-000348 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 20040331 FILED AS OF DATE: 20040514 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FRANKLIN RESOURCES INC CENTRAL INDEX KEY: 0000038777 STANDARD INDUSTRIAL CLASSIFICATION: INVESTMENT ADVICE [6282] IRS NUMBER: 132670991 STATE OF INCORPORATION: DE FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-09318 FILM NUMBER: 04808793 BUSINESS ADDRESS: STREET 1: ONE FRANKLIN PARKWAY STREET 2: BUILDING 920 CITY: SAN MATEO STATE: CA ZIP: 94403 BUSINESS PHONE: 650-312-2000 MAIL ADDRESS: STREET 1: FRANKLIN RESOURCES INC STREET 2: ONE FRANKLIN PARKWAY CITY: SAN MATEO STATE: CA ZIP: 94403 10-Q 1 form10q_2q04.txt FOR PERIOD ENDED MARCH 31, 2004 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, 2004 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _________ to________ Commission File No. 1-9318 FRANKLIN RESOURCES, INC. (Exact name of registrant as specified in its charter) Delaware 13-2670991 (State or other jurisdiction (IRS Employer of incorporation or organization) Identification No.) One Franklin Parkway, San Mateo, CA 94403 (Address of Principal Executive Offices) (Zip Code) (650) 312-2000 (Registrant's telephone number, including area code) (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO ____ ----- Indicate by check mark whether the registrant is an accelerated filer (as described in Rule 12b-2 of the Exchange Act). YES X NO ____ ----- APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Outstanding: 249,989,679 shares, common stock, par value $.10 per share, at April 30, 2004. PART I - FINANCIAL INFORMATION ITEM 1. CONDENSED FINANCIAL STATEMENTS
FRANKLIN RESOURCES, INC. CONSOLIDATED STATEMENTS OF INCOME UNAUDITED THREE MONTHS ENDED SIX MONTHS ENDED MARCH 31, MARCH 31, (in thousands, except per share data) 2004 2003 2004 2003 - -------------------------------------------------------------------------------------------------------- OPERATING REVENUES: Investment management fees $499,595 $347,897 $954,103 $699,309 Underwriting and distribution fees 294,003 194,158 566,755 380,095 Shareholder servicing fees 61,724 55,315 123,062 103,366 Consolidated sponsored investment products income, net 1,483 -- 1,509 -- Other, net 17,836 15,765 35,381 35,816 - -------------------------------------------------------------------------------------------------------- Total operating revenues 874,641 613,135 1,680,810 1,218,586 - -------------------------------------------------------------------------------------------------------- OPERATING EXPENSES: Underwriting and distribution 264,368 173,068 510,247 341,915 Compensation and benefits 197,139 160,809 386,343 319,927 Information systems, technology and occupancy 68,413 71,404 138,061 143,999 Advertising and promotion 31,935 24,226 53,167 46,870 Amortization of deferred sales commissions 24,997 17,040 47,445 33,085 Amortization of intangible assets 4,401 4,238 8,803 8,472 Provision for governmental investigations, proceedings and actions 60,000 -- 60,000 -- September 11, 2001 recovery, net (30,277) -- (30,277) -- Other 28,455 22,644 58,951 45,157 - -------------------------------------------------------------------------------------------------------- Total operating expenses 649,431 473,429 1,232,740 939,425 - -------------------------------------------------------------------------------------------------------- Operating income 225,210 139,706 448,070 279,161 OTHER INCOME (EXPENSES): Consolidated sponsored investment products gains, net 5,819 -- 9,819 -- Investment and other income 28,946 15,558 45,137 27,861 Interest expense (7,799) (3,037) (14,910) (6,069) - -------------------------------------------------------------------------------------------------------- Other income, net 26,966 12,521 40,046 21,792 - -------------------------------------------------------------------------------------------------------- Income before taxes on income and cumulative effect of an accounting change 252,176 152,227 488,116 300,953 Taxes on income 79,385 42,624 147,808 81,590 - -------------------------------------------------------------------------------------------------------- Income before cumulative effect of an accounting change, net of tax 172,791 109,603 340,308 219,363 Cumulative effect of an accounting change, net of tax -- -- 4,779 -- - -------------------------------------------------------------------------------------------------------- NET INCOME $172,791 $109,603 $345,087 $219,363 - -------------------------------------------------------------------------------------------------------- BASIC EARNINGS PER SHARE: Income before cumulative effect of an accounting change $0.69 $0.43 $1.37 $0.85 Cumulative effect of an accounting change -- -- 0.02 -- - -------------------------------------------------------------------------------------------------------- NET INCOME $0.69 $0.43 $1.39 $0.85 - -------------------------------------------------------------------------------------------------------- DILUTED EARNINGS PER SHARE: Income before cumulative effect of an accounting change $0.68 $0.43 $1.35 $0.85 Cumulative effect of an accounting change -- -- 0.02 -- - -------------------------------------------------------------------------------------------------------- NET INCOME $0.68 $0.43 $1.37 $0.85 - -------------------------------------------------------------------------------------------------------- Dividends per share $0.085 $0.075 $0.170 $0.150 See accompanying notes to the consolidated financial statements.
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FRANKLIN RESOURCES, INC. CONSOLIDATED BALANCE SHEETS UNAUDITED MARCH 31, SEPTEMBER 30, (in thousands) 2004 2003 - ------------------------------------------------------------------------------------------------------ ASSETS Current assets: Cash and cash equivalents $2,392,665 $1,017,023 Receivables 442,086 338,292 Investment securities, trading 165,612 41,379 Investment securities, available-for-sale 411,687 1,480,554 Prepaid expenses and other 92,905 91,579 - ------------------------------------------------------------------------------------------------------ Total current assets 3,504,955 2,968,827 - ------------------------------------------------------------------------------------------------------ Banking/finance assets: Cash and cash equivalents 156,915 36,672 Loans held for sale, net 113,074 3,006 Loans receivable, net 350,324 467,666 Investment securities, available-for-sale 331,496 358,387 Other 49,413 52,694 - ------------------------------------------------------------------------------------------------------ Total banking/finance assets 1,001,222 918,425 - ------------------------------------------------------------------------------------------------------ Non-current assets: Investments, other 314,669 280,356 Deferred sales commissions 271,027 215,816 Property and equipment, net 486,644 356,772 Goodwill 1,380,888 1,335,517 Other intangible assets, net 680,190 684,281 Receivable from banking/finance group 94,865 102,864 Other 116,020 107,891 - ------------------------------------------------------------------------------------------------------ Total non-current assets 3,344,303 3,083,497 - ------------------------------------------------------------------------------------------------------ TOTAL ASSETS $7,850,480 $6,970,749 - ------------------------------------------------------------------------------------------------------ See accompanying notes to the consolidated financial statements.
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FRANKLIN RESOURCES, INC. CONSOLIDATED BALANCE SHEETS UNAUDITED MARCH 31, SEPTEMBER 30, (in thousands, except share data) 2004 2003 - ----------------------------------------------------------------------------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Compensation and benefits $192,413 $225,446 Current maturities of long-term debt 164,900 287 Accounts payable and accrued expenses 183,398 112,630 Commissions 120,545 95,560 Income taxes 55,907 43,500 Other 12,223 11,103 - ----------------------------------------------------------------------------------------------------------- Total current liabilities 729,386 488,526 - ----------------------------------------------------------------------------------------------------------- Banking/finance liabilities: Deposits 685,389 633,983 Payable to parent 94,865 102,864 Other 63,165 65,133 - ----------------------------------------------------------------------------------------------------------- Total banking/finance liabilities 843,419 801,980 - ----------------------------------------------------------------------------------------------------------- Non-current liabilities: Long-term debt 1,157,828 1,108,881 Deferred taxes 218,175 203,498 Other 38,779 32,412 - ----------------------------------------------------------------------------------------------------------- Total non-current liabilities 1,414,782 1,344,791 - ----------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------- Total liabilities 2,987,587 2,635,297 - ----------------------------------------------------------------------------------------------------------- Minority interest 62,040 25,344 Commitments and contingencies (Note 13) Stockholders' equity: Preferred stock, $1.00 par value, 1,000,000 shares authorized; none issued -- -- Common stock, $0.10 par value, 500,000,000 shares authorized; 249,934,234 and 245,931,522 shares issued and outstanding, for March 31, 2004 and September 30, 2003 24,993 24,593 Capital in excess of par value 260,513 108,024 Retained earnings 4,432,393 4,129,644 Accumulated other comprehensive income 82,954 47,847 - ----------------------------------------------------------------------------------------------------------- Total stockholders' equity 4,800,853 4,310,108 - ----------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $7,850,480 $6,970,749 - ----------------------------------------------------------------------------------------------------------- See accompanying notes to the consolidated financial statements.
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FRANKLIN RESOURCES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS UNAUDITED SIX MONTHS ENDED MARCH 31, (in thousands) 2004 2003 - ------------------------------------------------------------------------------------------------------ NET INCOME $345,087 $219,363 Adjustments to reconcile net income to net cash provided by operating activities: (Increase) decrease in receivables, prepaid expenses and other (94,360) 29,863 Deferred sales commission advances (102,655) (65,381) Increase in other current liabilities 103 2,290 Provision for governmental investigations, proceedings and actions 60,000 -- Increase in deferred income taxes and taxes payable 7,272 1,656 Increase in commissions payable 24,985 374 Decrease (increase) in accrued compensation and benefits 9,986 (27,870) Originations of loans held for sale, net (110,068) -- Depreciation and amortization 92,131 87,926 Net (gains) losses on disposal of assets (13,090) 2,240 - ------------------------------------------------------------------------------------------------------ Net cash provided by operating activities 219,391 250,461 - ------------------------------------------------------------------------------------------------------ Purchase of investments (1,381,268) (1,114,217) Liquidation of investments 2,393,878 897,620 Purchase of banking/finance investments (705) (108,547) Liquidation of banking/finance investments 36,128 168,596 Net proceeds from securitization of loans receivable 226,527 124,989 Net origination of loans receivable (105,666) (198,589) Additions of property and equipment, net (7,445) (31,909) Acquisition of subsidiaries, net of cash acquired (69,904) -- Insurance proceeds related to September 11, 2001 event 32,487 -- - ------------------------------------------------------------------------------------------------------ Net cash provided by (used in) investing activities 1,124,032 (262,057) - ------------------------------------------------------------------------------------------------------ Increase (decrease) in bank deposits 51,406 (13,382) Exercise of common stock options 111,622 729 Net put option premiums and settlements -- 2,862 Dividends paid on common stock (39,608) (37,404) Purchase of stock (14,697) (133,322) Increase in debt 56,905 42,686 Payments on debt (13,166) (6,291) - ------------------------------------------------------------------------------------------------------ Net cash provided by (used in) financing activities 152,462 (144,122) - ------------------------------------------------------------------------------------------------------ Increase (decrease) in cash and cash equivalents 1,495,885 (155,718) Cash and cash equivalents, beginning of period 1,053,695 980,604 - ------------------------------------------------------------------------------------------------------ CASH AND CASH EQUIVALENTS, END OF PERIOD $2,549,580 $824,886 - ------------------------------------------------------------------------------------------------------ SUPPLEMENTAL DISCLOSURE OF NON-CASH INFORMATION: Value of common stock issued, principally restricted stock $47,209 $28,376 Total assets related to the consolidation of certain sponsored investment products and a lessor trust 215,378 -- Total liabilities related to the consolidation of certain sponsored investment products and a lessor trust 223,186 -- Fair value of Darby assets acquired 29,561 -- Fair value of Darby liabilities assumed 4,596 -- See accompanying notes to the consolidated financial statements.
5 FRANKLIN RESOURCES, INC. Notes to Consolidated Financial Statements March 31, 2004 (Unaudited) 1. BASIS OF PRESENTATION --------------------- We have prepared these unaudited interim financial statements of Franklin Resources, Inc. and its consolidated subsidiaries in accordance with the instructions to Form 10-Q and the rules and regulations of the U.S. Securities and Exchange Commission (the "SEC"). Under these rules and regulations, we have shortened or omitted some information and footnote disclosures normally included in financial statements prepared under generally accepted accounting principles. We believe that we have made all adjustments necessary for a fair statement of the financial position and the results of operations for the periods shown. All adjustments are normal and recurring. You should read these financial statements together with our audited financial statements included in our Annual Report on Form 10-K for the year ended September 30, 2003. Certain amounts for the comparative prior year periods have been reclassified to conform to the financial presentation for and at the periods ended March 31, 2004. 2. NEW ACCOUNTING STANDARDS ------------------------ In January 2003, the Financial Accounting Standards Board ("FASB") issued Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"). Under FIN 46, a variable interest entity ("VIE") is an entity in which the equity investment holders have not contributed sufficient capital to finance the activities of the VIE or the equity investment holders do not have defined rights and obligations normally associated with an equity investment. FIN 46 requires consolidation of a VIE by the enterprise that has the majority of the risks and rewards of ownership, referred to as the primary beneficiary. The consolidation and disclosure provisions of FIN 46 were effective immediately for VIEs created after January 31, 2003. Effective July 1, 2003, six of our sponsored investment products created after January 31, 2003 were consolidated in our financial statements. In December 2003, the FASB published FASB Interpretation No. 46, "Consolidation of Variable Interest Entities (revised December 2003)" ("FIN 46-R"), clarifying FIN 46 and exempting certain entities from the provisions of FIN 46. Generally, application of FIN 46-R is required in financial statements of public entities that have interests in structures commonly referred to as special-purpose entities for periods ending after December 15, 2003, and, for other types of VIEs, for periods ending after March 15, 2004. We early adopted FIN 46-R as of December 31, 2003, and, as a result, we recognized a cumulative effect of an accounting change, net of tax, of $4.8 million as of this date to reflect the accumulated retained earnings of VIEs in which we became an interest holder prior to February 1, 2003 (see Notes 7 and 13). In December 2003, the FASB issued Statement of Financial Accounting Standards ("SFAS") No. 132 (revised 2003), "Employers' Disclosures about Pensions and Other Postretirement Benefits, an amendment of FASB Statements No. 87, 88, and 106" ("SFAS 132"). SFAS 132 revises employers' disclosures about pension plans and other post-retirement benefits plans and requires additional disclosures about the assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other defined benefit post-retirement plans. SFAS 132 is effective for financial statements relating to fiscal years ending after December 15, 2003. The interim-period disclosure requirements for SFAS 132 were effective for interim periods beginning after December 15, 2003 (see Note 12). 3. ACQUISITIONS ------------ On October 1, 2003, we acquired the remaining 87.3% interest in Darby Overseas Investments, Ltd. and Darby Overseas Partners, L.P. (collectively "Darby") that we did not own for an additional cash investment of approximately $75.9 million. The acquisition cost was allocated to tangible net assets acquired ($30.9 million), definite-lived management contracts ($3.4 million) and goodwill ($41.6 million). These definite-lived intangible assets are being amortized over the remaining contractual life of the sponsored investment products, ranging from one to eight years. At September 30, 2003, Darby had approximately $0.9 billion in assets under management relating to private equity, mezzanine and emerging markets fixed-income products. 6 4. COMPREHENSIVE INCOME -------------------- The following table computes comprehensive income. THREE MONTHS ENDED SIX MONTHS ENDED MARCH 31, MARCH 31, (in thousands) 2004 2003 2004 2003 ------------------------------------------------------------------------------------------------- Net income $172,791 $109,603 $345,087 $219,363 Net unrealized gain (loss) on available-for-sale securities, net of tax 1,194 (4,629) 18,971 3,155 Foreign currency translation adjustments 4,030 3,464 16,819 11,221 Minimum pension liability adjustment -- -- (683) -- ------------------------------------------------------------------------------------------------- COMPREHENSIVE INCOME $178,015 $108,438 $380,194 $233,739 -------------------------------------------------------------------------------------------------
5. EARNINGS PER SHARE ------------------ We computed earnings per share as follows: THREE MONTHS ENDED SIX MONTHS ENDED MARCH 31, MARCH 31, (in thousands, except per share data) 2004 2003 2004 2003 ------------------------------------------------------------------------------------------------- Net income $172,791 $109,603 $345,087 $219,363 ------------------------------------------------------------------------------------------------- Weighted-average shares outstanding - basic 249,549 257,023 248,649 257,315 Incremental shares from assumed conversions 3,274 631 2,939 603 ------------------------------------------------------------------------------------------------- Weighted-average shares outstanding - diluted 252,823 257,654 251,588 257,918 ------------------------------------------------------------------------------------------------- BASIC EARNINGS PER SHARE: Income before cumulative effect of an accounting change $0.69 $0.43 $1.37 $0.85 Cumulative effect of an accounting change -- -- 0.02 -- ------------------------------------------------------------------------------------------------- Net income $0.69 $0.43 $1.39 $0.85 ------------------------------------------------------------------------------------------------- DILUTED EARNINGS PER SHARE: Income before cumulative effect of an accounting change $0.68 $0.43 $1.35 $0.85 Cumulative effect of an accounting change -- -- 0.02 -- ------------------------------------------------------------------------------------------------- Net income $0.68 $0.43 $1.37 $0.85 -------------------------------------------------------------------------------------------------
6. EMPLOYEE STOCK OPTION AND INVESTMENT PLANS ------------------------------------------ Under our stock option plan, we may award options to some employees. In addition, we have a qualified, non-compensatory employee stock investment plan ("ESIP") allowing eligible participants to buy our common stock at 90% of its market value on defined dates and to receive a 50% match of the shares purchased if held for a defined period. We account for these plans using the intrinsic value method under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations. Accordingly, no compensation costs are recognized with respect to stock options granted that have an exercise price equal to the market value of the underlying stock at the date of grant, or with respect to shares purchased at a discount under the ESIP. Matching grants provided to ESIP participants, however, are recognized as expenses during the required holding period. If we had determined compensation costs for our stock option plans and the discount available on our ESIP based upon fair values at the grant dates in accordance with the provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation", our net income and earnings per share would have been reduced to the pro forma amounts indicated below. For pro forma purposes, the 7 estimated fair value of options was calculated using the Black-Scholes option-pricing model and is amortized over the options' vesting periods. THREE MONTHS ENDED SIX MONTHS ENDED MARCH 31, MARCH 31, (in thousands) 2004 2003 2004 2003 ------------------------------------------------------------------------------------------------ Net income, as reported $172,791 $109,603 $345,087 $219,363 Less: stock-based compensation expense determined under the fair value method, net of tax (12,186) (17,414) (22,992) (33,949) ------------------------------------------------------------------------------------------------ PRO FORMA NET INCOME $160,605 $92,189 $322,095 $185,414 ------------------------------------------------------------------------------------------------ BASIC EARNINGS PER SHARE: As reported $0.69 $0.43 $1.39 $0.85 Pro forma 0.64 0.36 1.30 0.72 DILUTED EARNINGS PER SHARE: As reported $0.68 $0.43 $1.37 $0.85 Pro forma 0.64 0.36 1.28 0.72 ------------------------------------------------------------------------------------------------
7. CONSOLIDATED SPONSORED INVESTMENT PRODUCTS ------------------------------------------ The following tables present the effect on our consolidated results of operations and financial position of consolidating majority-owned sponsored investment products. THREE MONTHS ENDED MARCH 31, 2004 -------------------------------------------------- BEFORE CONSOLIDATION SPONSORED OF SPONSORED INVESTMENT (in thousands) INVESTMENT PRODUCTS PRODUCTS CONSOLIDATED ------------------------------------------------------------------------------------------------ OPERATING REVENUES: Investment management fees $500,229 $(634) $499,595 Underwriting and distribution fees 294,003 -- 294,003 Shareholder servicing fees 61,724 -- 61,724 Consolidated sponsored investment products income, net -- 1,483 1,483 Other, net 17,836 -- 17,836 ------------------------------------------------------------------------------------------------ Total operating revenues 873,792 849 874,641 ------------------------------------------------------------------------------------------------ OPERATING EXPENSES 649,431 -- 649,431 ------------------------------------------------------------------------------------------------ Operating income 224,361 849 225,210 ------------------------------------------------------------------------------------------------ OTHER INCOME (EXPENSES): Consolidated sponsored investment product gains, net -- 5,819 5,819 Investment and other income 30,505 (1,559) 28,946 Interest expense (7,799) -- (7,799) ------------------------------------------------------------------------------------------------ Other income, net 22,706 4,260 26,966 ------------------------------------------------------------------------------------------------ Income before taxes on income and cumulative effect of an accounting change 247,067 5,109 252,176 Taxes on income 77,904 1,481 79,385 ------------------------------------------------------------------------------------------------ Income before cumulative effect of an accounting change, net of tax 169,163 3,628 172,791 Cumulative effect of an accounting change, net of tax -- -- -- ------------------------------------------------------------------------------------------------ NET INCOME $169,163 $3,628 $172,791 ------------------------------------------------------------------------------------------------
8 SIX MONTHS ENDED MARCH 31, 2004 -------------------------------------------------- BEFORE CONSOLIDATION SPONSORED OF SPONSORED INVESTMENT (in thousands) INVESTMENT PRODUCTS PRODUCTS CONSOLIDATED ------------------------------------------------------------------------------------------------ OPERATING REVENUES: Investment management fees $954,875 $(772) $954,103 Underwriting and distribution fees 566,757 (2) 566,755 Shareholder servicing fees 123,076 (14) 123,062 Consolidated sponsored investment products income, net -- 1,509 1,509 Other, net 35,381 -- 35,381 ------------------------------------------------------------------------------------------------ Total operating revenues 1,680,089 721 1,680,810 ------------------------------------------------------------------------------------------------ OPERATING EXPENSES 1,232,740 -- 1,232,740 ------------------------------------------------------------------------------------------------ Operating income 447,349 721 448,070 ------------------------------------------------------------------------------------------------ OTHER INCOME (EXPENSES): Consolidated sponsored investment product gains, net -- 9,819 9,819 Investment and other income 48,247 (3,110) 45,137 Interest expense (14,910) -- (14,910) ------------------------------------------------------------------------------------------------ Other income, net 33,337 6,709 40,046 ------------------------------------------------------------------------------------------------ Income before taxes on income and cumulative effect of an accounting change 480,686 7,430 488,116 Taxes on income 145,654 2,154 147,808 ------------------------------------------------------------------------------------------------ Income before cumulative effect of an accounting change, net of tax 335,032 5,276 340,308 Cumulative effect of an accounting change, net of tax (3,189) 7,968 4,779 ------------------------------------------------------------------------------------------------ NET INCOME $331,843 $13,244 $345,087 ------------------------------------------------------------------------------------------------
AS OF MARCH 31, 2004 -------------------------------------------------- BEFORE CONSOLIDATION SPONSORED OF SPONSORED INVESTMENT (in thousands) INVESTMENT PRODUCTS PRODUCTS CONSOLIDATED ------------------------------------------------------------------------------------------------ ASSETS Current assets $3,442,046 $62,909 $3,504,955 Banking/finance assets 1,001,222 -- 1,001,222 Non-current assets 3,344,303 -- 3,344,303 ------------------------------------------------------------------------------------------------ TOTAL ASSETS $7,787,571 $62,909 $7,850,480 ------------------------------------------------------------------------------------------------ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities $704,237 $25,149 $729,386 Banking/finance liabilities 843,419 -- 843,419 Non-current liabilities 1,414,782 -- 1,414,782 ------------------------------------------------------------------------------------------------ Total liabilities 2,962,438 25,149 2,987,587 Minority interest 24,280 37,760 62,040 Total stockholders' equity 4,800,853 -- 4,800,853 ------------------------------------------------------------------------------------------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $7,787,571 $62,909 $7,850,480 ------------------------------------------------------------------------------------------------
9 8. CASH AND CASH EQUIVALENTS ------------------------- Cash and cash equivalents consist of the following: MARCH 31, SEPTEMBER 30, (in thousands) 2004 2003 ------------------------------------------------------------------------------------------------------- Cash and due from banks $820,031 $260,530 Federal funds sold and securities purchased under agreements to resell 109,968 3,741 Money market funds, time deposits and other 1,619,581 789,424 ------------------------------------------------------------------------------------------------------- TOTAL $2,549,580 $1,053,695 -------------------------------------------------------------------------------------------------------
Federal Reserve Board regulations required reserve balances of $1.8 million at March 31, 2004 and $1.5 million at September 30, 2003. 9. SECURITIZATION OF LOANS RECEIVABLE ---------------------------------- From time to time, we enter into auto loan securitization transactions with qualified special purpose entities and record these transactions as sales. The following table shows details of auto loan securitization transactions. THREE MONTHS ENDED SIX MONTHS ENDED MARCH 31, MARCH 31, (in thousands) 2004 2003 2004 2003 ------------------------------------------------------------------------------------------------- Gross sale proceeds $46,715 $-- $231,786 $131,620 Less: net carrying amount of loans sold 45,230 -- 226,068 126,104 ------------------------------------------------------------------------------------------------- PRE-TAX GAIN $1,485 $-- $5,718 $5,516 -------------------------------------------------------------------------------------------------
When we sell auto loans in a securitization transaction, we record an interest-only strip receivable. The interest-only strip receivable represents our contractual right to receive interest from the pool of securitized loans after the payment of required amounts to holders of the securities and certain other costs associated with the securitization. Gross sales proceeds include the fair value of the interest-only strips. We generally estimate fair value based on the present value of future expected cash flows. The key assumptions used in the present value calculations of our securitization transactions at the date of securitization were as follows: THREE MONTHS ENDED SIX MONTHS ENDED MARCH 31, MARCH 31, 2004 2003 2004 2003 ------------------------------------------------------------------------------------------------- Excess cash flow discount rate (annual rate) 12.0% -- 12.0% 12.0% Cumulative life loss rate 3.4% -- 3.4% 4.3% Pre-payment speed assumption (average monthly rate) 1.8% -- 1.8% 1.8% -------------------------------------------------------------------------------------------------
We determined these assumptions using data from comparable transactions, historical information and management's estimate. Interest-only strip receivables are generally restricted assets and subject to limited recourse provisions. 10 We generally estimate the fair value of the interest-only strips at each period-end based on the present value of future expected cash flows, consistent with the methodology used at the date of securitization. The following shows the carrying value and the sensitivity of the interest-only strip receivable to hypothetical adverse changes in the key economic assumptions used to measure fair value: MARCH 31, SEPTEMBER 30, (in thousands) 2004 2003 ----------------------------------------------------------------- --------------- --------------- CARRYING AMOUNT/FAIR VALUE OF INTEREST-ONLY STRIPS $35,741 $36,010 -------------------------------------------------- EXCESS CASH FLOW DISCOUNT RATE (ANNUAL RATE) 12.0% 12.0% -------------------------------------------- Impact on fair value of 10% adverse change $(486) $(493) Impact on fair value of 20% adverse change (958) (971) CUMULATIVE LIFE LOSS RATE 3.9% 3.9% ------------------------- Impact on fair value of 10% adverse change $(2,390) $(2,412) Impact on fair value of 20% adverse change (4,780) (4,725) PRE-PAYMENT SPEED ASSUMPTION (AVERAGE MONTHLY RATE) 1.8% 1.8% --------------------------------------------------- Impact on fair value of 10% adverse change $(3,363) $(3,505) Impact on fair value of 20% adverse change (6,442) (7,051) -------------------------------------------------------------------------------------------------
Actual future market conditions may differ materially. Accordingly, this sensitivity analysis should not be considered our projection of future events or losses. We receive annual servicing fees ranging from 1% to 2% of the loans securitized for services we provide to the securitization trusts. The following is a summary of cash flows received from and paid to securitization trusts. THREE MONTHS ENDED SIX MONTHS ENDED MARCH 31, MARCH 31, (in thousands) 2004 2003 2004 2003 ------------------------------------------------------------------------------------------------- Servicing fees received $3,708 $2,696 $6,797 $5,069 Other cash flows received 5,239 4,266 10,704 9,132 Purchase of loans from trusts 11,459 10,363 11,837 10,363 -------------------------------------------------------------------------------------------------
Amounts payable to the trustee related to loan principal and interest collected on behalf of the trusts of $39.0 million at March 31, 2004, and $34.4 million at September 30, 2003, are included in other banking/finance liabilities. The securitized loan portfolio that we manage and the related delinquencies were as follows: MARCH 31, SEPTEMBER 30, (in thousands) 2004 2003 ------------------------------------------------------------------------------------------------- Securitized loans held by securitization trusts $718,971 $680,695 Delinquencies 10,506 12,911 -------------------------------------------------------------------------------------------------
Net charge-offs on the securitized loan portfolio were $3.7 million and $8.8 million for the three and six months ended March 31, 2004 and $3.0 million and $6.0 million for the three and six months ended March 31, 2003. 11 10. GOODWILL AND OTHER INTANGIBLE ASSETS ------------------------------------ Intangible assets, other than goodwill were as follows: GROSS CARRYING ACCUMULATED NET CARRYING (in thousands) AMOUNT AMORTIZATION AMOUNT ------------------------------------------------------------------------------------------------- BALANCE, MARCH 31, 2004 Amortized intangible assets: Customer base $232,956 $(46,866) $186,090 Other 34,932 (20,691) 14,241 ------------------------------------------------------------------------------------------------- 267,888 (67,557) 200,331 Non-amortized intangible assets: Management contracts 479,859 -- 479,859 ------------------------------------------------------------------------------------------------- TOTAL $747,747 $(67,557) $680,190 -------------------------------------------------------------------------------------------------
GROSS CARRYING ACCUMULATED NET CARRYING (in thousands) AMOUNT AMORTIZATION AMOUNT ------------------------------------------------------------------------------------------------- BALANCE, SEPTEMBER 30, 2003 Amortized intangible assets: Customer base $232,800 $(39,057) $193,743 Other 31,546 (19,653) 11,893 ------------------------------------------------------------------------------------------------- 264,346 (58,710) 205,636 Non-amortized intangible assets: Management contracts 478,645 -- 478,645 ------------------------------------------------------------------------------------------------- TOTAL $742,991 $(58,710) $684,281 -------------------------------------------------------------------------------------------------
Estimated amortization expense for each of the next 5 fiscal years is as follows: FOR THE FISCAL YEARS ENDING (in thousands) SEPTEMBER 30, -------------------------------------------- ------------------------------ 2004 $17,227 2005 17,227 2006 17,227 2007 17,227 2008 17,227 -------------------------------------------- ------------------------------ The change in the carrying value of goodwill was as follows: (in thousands) --------------------------------------------------------------------------- Goodwill as of September 30, 2003 $1,335,517 Darby acquisition (see Note 3) 41,553 Foreign currency movements 3,818 --------------------------------------------------------------------------- GOODWILL AS OF MARCH 31, 2004 $1,380,888 --------------------------------------------------------------------------- All of our goodwill and intangible assets, including those arising from the purchase of Fiduciary Trust Company International ("Fiduciary Trust") in April 2001, relate to our investment management operating segment. Non-amortized intangible assets represent the value of management contracts related to certain of our sponsored investment products that are indefinite-lived. During the quarter ended March 31, 2004, we 12 completed our annual impairment testing of goodwill and indefinite-lived intangible assets under the guidance set out in SFAS No. 142, "Goodwill and Other Intangible Assets", and we determined that there was no impairment in the value of these assets as of October 1, 2003. 11. DEBT ---- Outstanding debt consisted of the following: MARCH 31, SEPTEMBER 30, (in thousands) 2004 2003 ------------------------------------------------------------------------------------------------- SHORT-TERM: Federal Home Loan Bank advances $12,000 $14,500 Current maturities of long-term debt 164,900 287 ----------------------------------------------------------------- --------------- --------------- 176,900 14,787 LONG-TERM: Convertible Notes (including accrued interest) 525,190 520,325 Medium Term Notes 420,000 420,000 Other 212,638 168,556 ----------------------------------------------------------------- --------------- --------------- 1,157,828 1,108,881 ----------------------------------------------------------------- --------------- --------------- TOTAL DEBT $1,334,728 $1,123,668 ----------------------------------------------------------------- --------------- ---------------
Federal Home Loan Bank advances are included in other liabilities of the banking/finance operating segment. On December 31, 2003, we recognized a $164.9 million five-year note facility that was used to finance the construction of our corporate headquarters campus under the guidance of FIN 46-R. The facility expires in September 2004 and will continue to be classified as a current liability until it is refinanced or repaid. In May 2001, we received approximately $490.0 million in net proceeds from the sale of $877.0 million principal amount at maturity of zero-coupon convertible senior notes due 2031 (the "Convertible Notes"). The Convertible Notes, which were offered to qualified institutional buyers only, carry an interest rate of 1.875% per annum, with an initial conversion premium of 43%. Each of the $1,000 (principal amount at maturity) Convertible Notes is convertible into 9.3604 shares of our common stock, when the price of our stock reaches certain thresholds. We may redeem the Convertible Notes for cash on or after May 11, 2006 at their accreted value. On May 12, 2003, at the option of the holders, we repurchased Convertible Notes with a face value of $5.9 million principal amount at maturity, for their accreted value of $3.5 million in cash. In addition, on May 12, 2004, we repurchased $11 thousand face value of the Convertible Notes at their accreted value. We may have to make additional repurchases, at the option of the holders, on May 11 of 2006, 2011, 2016, 2021 and 2026. In this event, we may choose to repay the accreted value of the Convertible Notes in cash or shares of our common stock. The amount that will be redeemed by the holders, depends on, among other factors, the performance of our common stock. In April 2003, we completed the sale of five-year senior notes due April 15, 2008 totaling $420.0 million ("Medium Term Notes"). The Medium Term Notes, which were offered to qualified institutional buyers only, carry an interest rate of 3.7% and are not redeemable prior to maturity by either us or the note holders. Interest payments are due semi-annually. Other long-term debt consists primarily of deferred commission liabilities recognized in relation to U.S. deferred commission assets financed by Lightning Finance Company Limited ("LFL") that were not sold by LFL in a securitization transaction as of March 31, 2004 and September 30, 2003. 12. PENSIONS AND OTHER POSTRETIREMENT BENEFITS ------------------------------------------ Fiduciary Trust has a noncontributory retirement plan (the "Retirement Plan") covering substantially all its employees hired before we acquired it. Fiduciary Trust also maintains a nonqualified supplementary executive retirement plan ("SERP") to pay defined benefits in excess of limits imposed by Federal tax law to participants in the retirement plan who attain age 55 and ten years of service as of the plan termination date. In April 2003, the Board of Directors of Fiduciary Trust approved a resolution to terminate both the Retirement Plan and the SERP as of June 30, 2003. In December 2003, Fiduciary Trust filed for approval 13 of the Retirement Plan termination with the Internal Revenue Service. Since Fiduciary Trust has not been notified that the Internal Revenue Service has approved the Retirement Plan termination, a curtailment gain (loss) has not yet been recorded in accordance with Statement of Financial Accounting Standards No. 88, "Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits". In addition to these pension plans, Fiduciary Trust sponsors a defined benefit healthcare plan that provides post-retirement medical benefits to full-time employees who have worked ten years and attained age 55 while in the service of Fiduciary Trust, or have met alternate eligibility criteria. The defined benefit healthcare plan was closed to new entrants in April 2003. The following table summarizes the components of net periodic benefit cost for the Retirement Plan and SERP, under pension benefits, and for the defined healthcare plan, under other benefits. PENSION BENEFITS OTHER BENEFITS ------------------------------------------------------------ THREE MONTHS ENDED THREE MONTHS ENDED MARCH 31, MARCH 31, (in thousands) 2004 2003 2004 2003 -------------------------------------------------------------------------------------------------- Service cost $-- $242 $12 $7 Interest cost 391 323 101 80 Expected return on plan assets (226) (193) -- -- Amortization of prior service costs -- (32) 64 -- Amortization of net (gain) loss 67 950 17 -- -------------------------------------------------------------------------------------------------- NET PERIODIC BENEFIT COST $232 $1,290 $194 $87 --------------------------------------------------------------------------------------------------
In the six months ended March 31, 2004, we have not made any contribution to the Retirement Plan. Based on our most recent valuation, we anticipate that we will contribute an additional $10.3 million to the Retirement Plan and an additional $4.2 million to the SERP, when final approval of the Retirement Plan termination is received from the Internal Revenue Service. We accrued the benefit liability for this anticipated funding in our financial statements as of the fiscal year ended September 30, 2003. 13. COMMITMENTS AND CONTINGENCIES ----------------------------- Guarantees Under Financial Accounting Standards Board Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others", we are required, on a prospective basis, to recognize in our financial statements a liability for the fair value of any guarantees issued or modified after December 31, 2002 as well as make additional disclosures about existing guarantees. In October 1999, we entered into an agreement for the lease of our corporate headquarters campus in San Mateo, California from a lessor trust under an operating lease that expires in fiscal 2005, with additional renewal options for a further period of up to 10 years. In connection with this lease, we are contingently liable for approximately $145.0 million in residual guarantees, representing approximately 85% of the total construction costs of $170.0 million. We would become liable under this residual guarantee if we were unable or unwilling to exercise our renewal option to extend the lease term or buy the corporate headquarters campus, or if we were unable to arrange for the sale of the campus for more than $145.0 million. We are also contingently liable to purchase the corporate headquarters campus for an amount equal to the final construction costs of $170.0 million if an event of default occurs under the agreement. An event of default includes, but is not limited to, failure to make lease payments when due and failure to maintain required insurance. Management considers the possibility of default under the provisions of the agreement to be remote. On December 31, 2003, we consolidated the lessor trust under the provisions of FIN 46-R and recognized, as a current liability, the loan principal of $164.9 million and minority interest of $5.1 million, which, in total, represent the amount used to finance the construction of our corporate headquarters campus and our maximum contingent liability under the agreements. 14 In relation to the auto loan securitization transactions that we have entered into with a number of qualified special purpose entities, we are obligated to cover shortfalls in amounts due to the holders of the notes up to certain levels as specified under the related agreements. As of March 31, 2004, the maximum potential amount of future payments was $18.0 million relating to guarantees made prior to January 1, 2003. In addition, our consolidated balance sheet at March 31, 2004 included a $0.3 million liability to reflect obligations arising from auto securitization transactions subsequent to December 31, 2002. At March 31, 2004, our banking/finance operating segment had issued financial standby letters of credit totaling $2.5 million on which beneficiaries would be able to draw upon in the event of non-performance by our customers, primarily in relation to lease and lien obligations of these banking customers. These standby letters of credit, issued prior to January 1, 2003, were secured by marketable securities with a fair value of $3.2 million as of March 31, 2004 and commercial real estate. GOVERNMENTAL INVESTIGATIONS, PROCEEDINGS AND ACTIONS MASSACHUSETTS ADMINISTRATIVE PROCEEDING. On February 4, 2004, the Securities Division of the Office of the Secretary of the Commonwealth of Massachusetts filed an administrative complaint against Franklin Resources, Inc. and certain of its subsidiaries (the "Company") claiming violations of the Massachusetts Uniform Securities Act ("Massachusetts Act") with respect to an alleged arrangement to permit market timing (the "Mass Proceeding"). On February 14, 2004, the Company filed an answer denying all violations of the Massachusetts Act. GOVERNMENTAL INVESTIGATIONS. As part of ongoing investigations by the SEC, the U.S. Attorney for the Northern District of California, the New York Attorney General, the California Attorney General, the U.S. Attorney for the District of Massachusetts, the Florida Department of Financial Services and the Commissioner of Securities, the West Virginia Attorney General and the Vermont Department of Banking, Insurance, Securities, and Health Care Administration, relating to certain practices in the mutual fund industry, including late trading, market timing and payments to securities dealers who sell fund shares, the Company and its subsidiaries, as well as certain current or former executives and employees of the Company, have received requests for information and/or subpoenas to testify or produce documents. The Company and its current employees are providing documents and information in response to these requests and subpoenas. In addition, the Company has responded to requests for similar kinds of information from regulatory authorities in some of the foreign countries where the Company conducts its global asset management business. The staff of the SEC has informed the Company that it intends to recommend that the SEC authorize a civil injunctive action against Franklin Advisers, Inc., a subsidiary of the Company. The SEC's investigation is focused on the activities that are the subject of the Mass Proceeding described above and other instances of alleged market timing by a limited number of third parties that ended in 2000. The Company currently believes that the charges the SEC staff is contemplating are unwarranted. There are discussions underway with the SEC staff in an effort to resolve the issues raised in their investigation and, although there can be no assurance, a resolution of such issues may be reached with the SEC staff in the coming quarter. In the three months ended March 31, 2004, the Company recorded a charge to income of $60 million, which represents the costs that can be currently estimated related to ongoing governmental investigations, proceedings and actions. Separately, in response to requests for information and subpoenas from the SEC and the California Attorney General, the Company has provided documents and testimony has been taken relating to payments to securities dealers who sell shares of the Franklin, Templeton and Mutual Series U.S. Funds (each a "Fund" and together, "Funds"). Effective November 28, 2003, the Company determined not to direct any further brokerage commissions where the allocation is based, not only on best execution, but also on the sale of Fund shares, which determination may have an adverse impact on the Company. INTERNAL INQUIRIES. The Company also has conducted its own internal fact-finding inquiry with the assistance of outside counsel to determine whether any shareholders of the Funds, including Company employees, were permitted to engage in late trading or in market timing transactions contrary to the policies of the affected Fund and, if so, the circumstances and persons involved. The Company's internal inquiry regarding market timing and late trading is substantially complete. We have not found any late trading 15 problems, but we have identified various instances of frequent trading. One officer of a subsidiary of the Company had been placed on administrative leave and subsequently resigned from his position with the Company. As previously disclosed, the Company also has identified some instances of frequent trading in shares of certain Funds by a few current or former employees in their personal 401(k) plan accounts. These individuals included one trader and one officer of the Funds. Pending our further inquiry, these two individuals were placed on administrative leave and the officer resigned from his positions with the Funds. We have found no instances of inappropriate mutual fund trading by any portfolio manager, investment analyst or officer of Franklin Resources, Inc. The independent directors of the Funds and the Company also retained independent outside counsel to review these matters and to report their findings and recommendations. Based on independent counsel's findings and recommendations, the Company has reinstated the trader. The independent counsel has concluded that some instances of the former Fund officer's trading violated Company policy and recommended appropriate disciplinary action. The former Fund officer has subsequently resigned as an employee of the Company. The Company does not believe there were any losses to the Funds as a result of this trading. OTHER LEGAL PROCEEDINGS In addition, the Company and certain of its subsidiaries and current and former officers, employees, and directors have been named in multiple lawsuits in different federal courts in Nevada, California, Illinois, New York, New Jersey, and Florida, alleging violations of various federal securities laws and seeking, among other things, monetary damages and costs. Specifically, the lawsuits claim breach of duty with respect to alleged arrangements to permit market timing and/or late trading activity, or breach of duty with respect to the valuation of the portfolio securities of certain Templeton funds managed by Company subsidiaries, resulting in alleged market timing activity. The majority of these lawsuits duplicate, in whole or in part, the allegations asserted in the Mass Proceeding detailed above. The lawsuits are styled as class actions or derivative actions on behalf of either the named Funds or the Company. Management strongly believes that the claims made in each of these lawsuits, as more specifically described below, are without merit and intends to vigorously defend against them. To date, more than 240 similar lawsuits against 18 different mutual fund companies have been filed in federal court districts throughout the country. Because these cases involve common questions of fact, the Judicial Panel on Multidistrict Litigation (the "Judicial Panel") ordered the creation of a multidistrict litigation, entitled "In re Mutual Funds Investment Litigation," and transferred similar cases from different districts to a single district (the United States District Court for the District of Maryland) for coordinated or consolidated pretrial proceedings (the "MDL"). As of May 12, 2004, the following lawsuits are pending against the Company and have been transferred or conditionally transferred to the MDL: Kenerley v. Templeton Funds, Inc., et al., Case No. 03-770 GPM, filed on November 19, 2003 in the United States District Court for the Southern District of Illinois; Cullen v. Templeton Growth Fund, Inc., et al., Case No. 03-859 MJR, filed on December 16, 2003 in the United States District Court for the Southern District of Illinois and transferred to the United States District Court for the Southern District of Florida on March 29, 2004; Alexander v. Franklin AGE High Income Fund, et al., Case No. C 04 0639 SC, filed on February 17, 2004 in the United States District Court for the Northern District of California; Jaffe v. Franklin AGE High Income Fund, et al., Case No. CV-S-04-0146-PMP-RJJ, filed on February 6, 2004 in the United States District Court for the District of Nevada; Lum v. Franklin Resources, Inc., et al., Case No. C 04 0583 JSW, filed on February 11, 2004 in the United States District Court for the Northern District of California; Fischbein v. Franklin AGE High Income Fund, et al., Case No. C 04 0584 JSW, filed on February 11, 2004 in the United States District Court for the Northern District of California; Beer v. Franklin AGE High Income Fund, et al., Case No. 8:04-CV-249-T-26 MAP, filed on February 11, 2004 in the United States District Court for the Middle District of Florida; Bennett v. Franklin Resources, Inc., et al., Case No. CV-S-04-0154-HDM-RJJ, filed on February 12, 2004 in the United States District Court for the District of Nevada; Dukes v. Franklin AGE High Income Fund, et al., Case No. C 04 0598 MJJ, filed on February 12, 2004, in the United States District Court for the Northern District of California; McAlvey v. Franklin Resources, Inc., et al., Case No. C 04 0628 PJH, filed on February 13, 2004 in the United States 16 District Court for the Northern District of California; Hugh Sharkey IRA/RO v. Franklin Resources, Inc., et al., Case No. 04 CV 1330, filed on February 18, 2004 in the United States District Court for the Southern District of New York; Hertz v. Burns, et al., Case No. 04 CV 02489, filed on March 30, 2004 in the United States District Court for the Southern District of New York. The Company is awaiting the Judicial Panel's decision whether to transfer to the MDL the following additional federal lawsuits involving similar or identical allegations: D'Alliessi, et al. v. Franklin AGE High Income Fund, et al., Case No. C 04 0865 SC, filed on March 3, 2004 in the United States District Court for the Northern District of California; Marcus v. Franklin Resources, Inc., et al., Case No. C 04 0901 JL, filed on March 5, 2004 in the United States District Court for the Northern District of California; Banner v. Franklin Resources, Inc., et al., Case No. C 04 0902 JL, filed on March 5, 2004 in the United States District Court for the Northern District of California; Denenberg v. Franklin Resources, Inc., et al., Case No. C 04 0984 EMC, filed on March 10, 2004 in the United States District Court for the Northern District of California. Plaintiffs in the MDL proceeding have until May 28, 2004 to file their consolidated complaint(s). As previously reported, various subsidiaries of the Company have also been named in multiple lawsuits filed in state courts in Illinois alleging breach of duty with respect to the valuation of the portfolio securities of certain Templeton funds managed by such subsidiaries and are as follows: Bradfisch v. Templeton Funds, Inc., et al., Case No. 2003 L 001361, filed on October 3, 2003 in the Circuit Court of the Third Judicial Circuit, Madison County, Illinois; Woodbury v. Templeton Global Smaller Companies Fund, Inc., et al., Case No. 2003 L 001362, filed on October 3, 2003 in the Circuit Court of the Third Judicial Circuit, Madison County, Illinois; Kwiatkowski v. Templeton Growth Fund, Inc., et al., Case No. 03 L 785, filed on December 17, 2003 in the Circuit Court for the Twentieth Judicial Circuit, St. Clair County, Illinois; Parise v. Templeton Funds, Inc., et al., Case No. 2003 L 002049, filed on December 22, 2003 in the Circuit Court of the Third Judicial Circuit, Madison County, Illinois. These lawsuits are not subject to the MDL because they are state court actions. In addition, the Company and its subsidiaries, as well as certain current and former officers, employees, and directors, have been named in multiple lawsuits alleging violations of various securities laws and pendent state law claims relating to the disclosure of directed brokerage payments and payment of allegedly excessive commissions and advisory fees. These lawsuits are styled as class actions and derivative actions brought on behalf of certain funds, and are as follows: Stephen Alexander IRA v. Franklin Resources, Inc., et al., Case No. 04-982 (JLL), filed on March 2, 2004 in the United States District Court for the District of New Jersey; Strigliabotti v. Franklin Resources, Inc., et al., Case No. C 04 0883 SI, filed on March 4, 2004 in the United States District Court for the Northern District of California; Tricarico v. Franklin Resources, Inc., et al., Case No. CV-04-1052 (JAP), filed on March 4, 2004 in the United States District Court for the District of New Jersey; Miller v. Franklin Mutual Advisors, LLC, et al., Case No. 04-261 DRH, filed on April 16, 2004 in the United States District Court for the Southern District of Illinois. The Company cannot predict with certainty the eventual outcome of the foregoing Mass Proceeding, other governmental investigations or class actions or other lawsuits, nor whether they will have a material negative impact on the Company. Public trust and confidence are critical to the Company's business and any material loss of investor and/or client confidence could result in a significant decline in assets under management by the Company, which would have an adverse effect on future financial results. If the Company finds that it bears responsibility for any unlawful or inappropriate conduct that caused losses to our Funds, we are committed to making the Funds or their shareholders whole, as appropriate. The Company is committed to taking all appropriate actions to protect the interests of our Funds' shareholders. In addition, pending regulatory and legislative actions and reforms affecting the mutual fund industry may significantly increase the Company's costs of doing business and/or negatively impact its revenues, either of which could have a material negative impact on the Company's financial results. 17 OTHER COMMITMENTS AND CONTINGENCIES Under FIN 46-R, we have determined that we are a significant variable interest holder in a number of sponsored investment products as well as in LFL, a company incorporated in Ireland whose sole business purpose is to finance our deferred commission assets. As of March 31, 2004, total assets of sponsored investment products in which we held a significant interest were approximately $1,299.9 million and our exposure to loss as a result of our interest in these products was $177.6 million. LFL had approximately $429.0 million in total assets at March 31, 2004. Our exposure to loss related to our investment in LFL was limited to the carrying value of our investment in and loans to LFL, and interest and fees receivable from LFL aggregating approximately $51.3 million. This amount represents our maximum exposure to loss and does not reflect our estimate of the actual losses that could result from adverse changes. In July 2003, we renegotiated an agreement to outsource management of our data center and distributed server operations, originally signed in February 2001. We may terminate the amended agreement any time after July 1, 2006 by incurring a termination charge. The maximum termination charge payable will depend on the termination date of the amended agreement, the service levels before our termination of the agreement, costs incurred by our service provider to wind-down the services and costs associated with assuming equipment leases. As of March 31, 2004, we estimate that the termination fee payable in July 2006, not including costs associated with assuming equipment leases, would approximate $14.0 million and would decrease each month for the subsequent two years, reaching a payment of approximately $2.2 million in July 2008. We lease office space and equipment under long-term operating leases. As of March 31, 2004, there were no material changes in leasing arrangements that would have a significant effect on future minimum lease payments reported in our Annual Report on Form 10-K for the period ended September 30, 2003. From time to time, we sell put options giving the purchaser the right to sell shares of our common stock to us at a specified price upon exercise of the options on the designated expiration dates if certain conditions are met. The likelihood that we will have to purchase our stock and the purchase price is contingent on the market value of our stock when the put option contract becomes exercisable. At March 31, 2004, there were no put options outstanding. The 1.4 million put options outstanding at December 31, 2003 expired unexercised in January 2004. At March 31, 2004, our banking/finance operating segment had commitments to extend credit aggregating $262.7 million, primarily under credit card lines. 14. COMMON STOCK REPURCHASES ------------------------ During the six months ended March 31, 2004, we purchased and retired 0.3 million shares at a cost of $14.7 million. At March 31, 2004, approximately 14.3 million shares remained available for repurchase under board authorizations. During the six months ended March 31, 2003, we purchased and retired 4.3 million shares at a cost of $136.8 million. See also Part II, Item 2: Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities. 15. SEGMENT INFORMATION ------------------- We have two operating segments: investment management and banking/finance. We based our operating segment selection process primarily on services offered. The investment management segment derives substantially all its revenues and net income from providing investment advisory, administration, distribution and related services to the Franklin, Templeton, Mutual Series, Bissett and Fiduciary Trust funds, and institutional, high net-worth and private accounts and other investment products. The banking/finance segment offers selected retail-banking services to high net-worth individuals, foundations and institutions, and consumer lending. Our consumer lending activities include automotive lending related to the purchase, securitization, and servicing of retail installment sales contracts originated by independent automobile dealerships, consumer credit and debit cards, real estate equity lines, and home equity/mortgage lending. 18 Financial information for our two operating segments is presented in the table below. Operating revenues of the banking/finance segment are reported net of interest expense and provision for loan losses. THREE MONTHS ENDED SIX MONTHS ENDED MARCH 31, MARCH 31, (in thousands) 2004 2003 2004 2003 ------------------------------------------------------------------------------------------------ OPERATING REVENUES: Investment management $859,824 $600,787 $1,651,243 $1,190,082 Banking/finance 14,817 12,348 29,567 28,504 ------------------------------------------------------------------------------------------------ TOTAL $874,641 $613,135 $1,680,810 $1,218,586 ------------------------------------------------------------------------------------------------ INCOME BEFORE TAXES ON INCOME AND CUMULATIVE EFFECT OF AN ACCOUNTING CHANGE: Investment management $244,708 $146,777 $472,769 $285,712 Banking/finance 7,468 5,450 15,347 15,241 ------------------------------------------------------------------------------------------------ TOTAL $252,176 $152,227 $488,116 $300,953 ------------------------------------------------------------------------------------------------
Operating segment assets were as follows: MARCH 31, SEPTEMBER 30, (in thousands) 2004 2003 --------------------------------------------------------------------------- Investment management $6,849,258 $6,052,324 Banking/finance 1,001,222 918,425 --------------------------------------------------------------------------- TOTAL $7,850,480 $6,970,749 --------------------------------------------------------------------------- Operating revenues of the banking/finance segment included above were as follows: THREE MONTHS ENDED SIX MONTHS ENDED MARCH 31, MARCH 31, (in thousands) 2004 2003 2004 2003 ------------------------------------------------------------------------------------------------ Interest and fees on loans $6,493 $8,101 $13,768 $15,964 Interest and dividends on investment securities 3,182 5,852 6,362 10,862 ------------------------------------------------------------------------------------------------ Total interest income 9,675 13,953 20,130 26,826 Interest on deposits (1,055) (1,791) (2,249) (3,380) Interest on short-term debt (46) (110) (106) (198) Interest expense - inter-segment (224) (605) (713) (1,409) ------------------------------------------------------------------------------------------------ Total interest expense (1,325) (2,506) (3,068) (4,987) Net interest income 8,350 11,447 17,062 21,839 Other income 7,301 4,234 17,380 13,215 Provision for loan losses (834) (3,333) (4,875) (6,550) ------------------------------------------------------------------------------------------------ TOTAL OPERATING REVENUES $14,817 $12,348 $29,567 $28,504 ------------------------------------------------------------------------------------------------
Inter-segment interest payments from the banking/finance segment to the investment management segment are based on market rates prevailing at the inception of each loan. Inter-segment interest income and expense are not eliminated in our consolidated income statement. 16. BANKING REGULATORY RATIOS ------------------------- Following the acquisition of Fiduciary Trust in April 2001, we became a bank holding company and a financial holding company subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can result in certain mandatory, and possibly additional, discretionary actions by regulators that, if undertaken, could have a direct material 19 adverse effect on our financial statements. We must meet specific capital adequacy guidelines that involve quantitative measures of our assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. Our capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require us to maintain a minimum Tier 1 capital and Tier 1 leverage ratio (as defined in the regulations), as well as minimum Tier 1 and Total risk-based capital ratios (as defined in the regulations). Based on our calculations as of March 31, 2004, we exceeded the capital adequacy requirements applicable to us as listed below. THREE MONTHS ENDED MINIMUM FOR OUR CAPITAL (in thousands) MARCH 31, 2004 ADEQUACY PURPOSES -------------------------------------------- ----------------------- ---------------------------- Tier 1 capital $2,819,130 N/A Total risk-based capital 2,824,162 N/A Tier 1 leverage ratio 47% 4% Tier 1 risk-based capital ratio 68% 4% Total risk-based capital ratio 68% 8% -------------------------------------------- ----------------------- ----------------------------
17. SEPTEMBER 11, 2001 RECOVERY, NET -------------------------------- In January 2004, we received $32.5 million from our insurance carrier for claims related to the September 11, 2001 terrorist attacks that destroyed Fiduciary Trust's headquarters. These proceeds represented final recoveries for claims submitted to our insurance carrier. We realized a gain of $30.3 million, before income taxes of $12.0 million, in the reporting period ending March 31, 2004, in accordance with guidance provided under FASB Statement No. 5 "Accounting for Contingencies" and Emerging Issues Task Force Abstract "Accounting for the Impact of the Terrorist Attacks of September 11, 2001", as remaining contingencies related to our insurance claims have been resolved. 20 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS In this section we discuss our results of operations and our financial condition. In addition to historical information, we also make statements relating to the future, called "forward-looking" statements. These forward-looking statements involve a number of risks, uncertainties and other important factors that could cause our actual results and outcomes to differ materially from any future results or outcomes expressed or implied by such forward-looking statements. Forward-looking statements are our best prediction at the time they are made, and for this reason, you should not rely too heavily on them and should review the "Risk Factors" section set forth below and in our recent filings with the U.S. Securities and Exchange Commission (the "SEC"), which describes these risks, uncertainties and other important factors in more detail. GENERAL We derive substantially all of our operating revenues, operating expenses and net income from providing investment advisory and related services to retail mutual funds, institutional, high net-worth, and private accounts and other investment products. This is our main business activity and operating segment. The mutual funds and other products that we advise, collectively called our sponsored investment products, are distributed to the public globally under five distinct names: * Franklin * Templeton * Mutual Series * Bissett * Fiduciary Trust We sponsor a broad range of investment products including global/international equity, U.S. equity, hybrid/balanced, fixed-income and money market mutual funds, and other investment products that meet a wide variety of specific investment needs of individuals and institutions. The level of our revenues depends largely on the level and relative mix of assets under management. To a lesser degree, our revenues also depend on the level of mutual fund sales and the number of mutual fund shareholder accounts. The fees charged for our services are based on contracts with our sponsored investment products. These arrangements could change in the future. Our secondary business and operating segment is banking/finance. Our banking/finance group offers selected retail-banking services to high net-worth and other individuals, foundations and institutions, and consumer lending services. Our consumer lending activities include automotive lending related to the purchase, securitization, and servicing of retail installment sales contracts originated by independent automobile dealerships, consumer credit and debit cards, real estate equity lines, and home equity/mortgage lending. RESULTS OF OPERATIONS THREE MONTHS ENDED SIX MONTHS ENDED MARCH 31, PERCENT MARCH 31, PERCENT (in millions except per 2004 2003 CHANGE 2004 2003 CHANGE share data) - ----------------------------------------------------------------------------------------------------- NET INCOME $172.8 $109.6 58% $345.1 $219.4 57% EARNINGS PER COMMON SHARE Basic $0.69 $0.43 60% $1.39 $0.85 64% Diluted 0.68 0.43 58% 1.37 0.85 61% OPERATING MARGIN 26% 23% -- 27% 23% -- - -----------------------------------------------------------------------------------------------------
Net income increased 58% and 57% in the three and six months ended March 31, 2004, as compared to the same periods last year, due primarily to higher investment management and underwriting and distribution fees reflecting a 36% and 30% increase in simple monthly average assets under management and a 47% and 43% increase in gross sales over the same periods. The increase was partly offset by higher operating expenses including underwriting and distribution and compensation and benefits expenses, and a higher effective tax rate. 21
ASSETS UNDER MANAGEMENT (in billions) MARCH 31, 2004 MARCH 31, 2003 - ----------------------------------------------------------------------------------------------------- Equity: Global/international $126.7 $75.7 Domestic (U.S.) 66.0 42.7 - ----------------------------------------------------------------------------------------------------- Total equity 192.7 118.4 - ----------------------------------------------------------------------------------------------------- Hybrid/balanced 54.1 37.4 Fixed-income: Tax-free 53.0 52.3 Taxable Domestic (U.S.) 32.4 29.4 Global/international 13.6 9.4 - ----------------------------------------------------------------------------------------------------- Total fixed-income 99.0 91.1 - ----------------------------------------------------------------------------------------------------- Money market 5.8 5.5 - ----------------------------------------------------------------------------------------------------- TOTAL $351.6 $252.4 - ----------------------------------------------------------------------------------------------------- SIMPLE MONTHLY AVERAGE FOR THE THREE-MONTH PERIOD (1) $345.7 $255.1 - ----------------------------------------------------------------------------------------------------- SIMPLE MONTHLY AVERAGE FOR THE SIX-MONTH PERIOD (1) $331.6 $254.6 - ----------------------------------------------------------------------------------------------------- (1) Investment management fees from approximately 45% of our assets under management at March 31, 2004 were calculated using a daily average.
Our assets under management at March 31, 2004 were $351.6 billion, 39% higher than they were a year ago, primarily due to excess sales over redemptions of $24.2 billion and market appreciation of $76.5 billion. Simple monthly average assets, which are generally more indicative of investment management fee trends than the year over year change in ending assets under management, increased 36% and 30% for the three and six months ended March 31, 2004 over the same periods a year ago. The simple monthly average mix of assets under management is shown below. SIX MONTHS ENDED MARCH 31, 2004 2003 - ----------------------------------------------------------------------------------------------------- PERCENTAGE OF SIMPLE MONTHLY AVERAGE ASSETS UNDER MANAGEMENT Equity 54% 48% Fixed-income 29% 35% Hybrid/balanced 15% 15% Money market 2% 2% - ----------------------------------------------------------------------------------------------------- TOTAL 100% 100% - -----------------------------------------------------------------------------------------------------
For the six months ended March 31, 2004, the effective investment management fee rate increased to 0.575% from 0.549% in the same period last year. The change in the mix of assets under management, resulting from higher relative excess sales over redemptions and appreciation of equity as compared to fixed-income products, led to an increase in our effective investment management fee rate (investment management fees divided by simple monthly average assets under management). Generally, equity products carry a higher management fee rate than fixed-income and hybrid/balanced products. 22 Assets under management by shareholder location were as follows: MARCH 31, SEPTEMBER 30, (in billions) 2004 % OF TOTAL 2003 % OF TOTAL - ------------------------------------------- ------------- -------------- -------------- ------------- United States $260.0 74% $224.0 74% Canada 25.2 7% 21.5 7% Europe 25.1 7% 19.9 7% Global 17.5 5% 15.9 5% Asia/Pacific and other regions 23.8 7% 20.6 7% - ------------------------------------------- ------------- -------------- ------------- ------------- Total $351.6 100% $301.9 100% - ------------------------------------------- ------------- -------------- ------------- -------------
Components of the change in our assets under management were as follows: THREE MONTHS ENDED SIX MONTHS ENDED MARCH 31, PERCENT MARCH 31, PERCENT (in billions) 2004 2003 CHANGE 2004 2003 CHANGE - ----------------------------------------------------------------------------------------------------- Beginning assets under management $336.7 $257.7 31% $301.9 $247.8 22% Sales 25.8 17.6 47% 49.6 34.7 43% Reinvested distributions 0.9 0.6 50% 2.8 2.1 33% Redemptions (19.3) (15.1) 28% (35.7) (31.2) 14% Distributions (1.4) (1.1) 27% (4.1) (3.3) 24% Acquisitions -- -- -- 0.9 -- N/A Appreciation 8.9 (7.3) N/A 36.2 2.3 1,474% - ----------------------------------------------------------------------------------------------------- ENDING ASSETS UNDER MANAGEMENT $351.6 $252.4 39% $351.6 $252.4 39% - -----------------------------------------------------------------------------------------------------
For the three and six months ended March 31, 2004, excess sales over redemptions were $6.5 billion and $13.9 billion, as compared to $2.5 billion and $3.5 billion in the same periods last year. Market appreciation of $36.2 billion in the six months ended March 31, 2004 related primarily to our equity and hybrid/balanced products. Darby Overseas Investments, Ltd. and Darby Overseas Partners, L.P. (collectively "Darby") had $0.9 billion in assets under management, related to private equity, mezzanine and emerging markets fixed-income products as of the acquisition date, on October 1, 2003.
OPERATING REVENUES THREE MONTHS ENDED SIX MONTHS ENDED MARCH 31, PERCENT MARCH 31, PERCENT (in millions) 2004 2003 CHANGE 2004 2003 CHANGE - ----------------------------------------------------------------------------------------------------- Investment management fees $499.6 $347.8 44% $954.1 $699.3 36% Underwriting and distribution fees 294.0 194.2 51% 566.8 380.1 49% Shareholder servicing fees 61.7 55.3 12% 123.0 103.4 19% Consolidated sponsored investment products income, net 1.5 -- N/A 1.5 -- N/A Other, net 17.8 15.8 13% 35.4 35.8 (1%) - ----------------------------------------------------------------------------------------------------- TOTAL OPERATING REVENUES $874.6 $613.1 43% $1,680.8 $1,218.6 38% - -----------------------------------------------------------------------------------------------------
INVESTMENT MANAGEMENT FEES Investment management fees, accounting for 57% of our operating revenues for the three months ended March 31, 2004 and 2003, include fees for providing both investment advisory and administrative services to our sponsored investment products. These fees are generally calculated under contractual arrangements with our sponsored investment products as a percentage of the market value of assets under management. Annual rates vary by investment objective and type of services provided. 23 Investment management fees increased 44% and 36% for the three and six months ended March 31, 2004 compared to the same periods last year consistent with a 36% and 30% increase in simple monthly average assets under management over the same periods, and an increase in our effective fee rate resulting from a shift in asset mix toward equity products, which generally carry a higher management fee than fixed-income products. UNDERWRITING AND DISTRIBUTION FEES We earn underwriting fees from the sale of certain classes of sponsored investment products on which investors pay a sales commission at the time of purchase. Sales commissions are reduced or eliminated on some classes of shares and for sales to shareholders or intermediaries that exceed specified minimum amounts. Therefore, underwriting fees will change with the size of individual sale transactions and the relative mix of sales between different share classes. Many of our sponsored investment products pay distribution fees in return for sales, marketing and distribution efforts on their behalf. While other contractual arrangements exist in international jurisdictions, in the United States, distribution fees include "12b-1 fees". These fees are subject to maximum payout levels based on a percentage of the assets in each fund and other regulatory limitations. We pay a significant portion of underwriting and distribution fees to the financial advisors and other intermediaries who sell our sponsored investment products to the public on our behalf. See the description of underwriting and distribution expenses below. Underwriting and distribution fees increased 51% and 49% for the three and six months ended March 31, 2004 compared to the same periods last year. For the three and six months ended March 31, 2004, commission revenues increased 65% from the same periods last year consistent with a 47% and 43% increase in gross sales and a change in the sales mix. Distribution fees increased 43% and 39% for the three and six months ended March 31, 2004 over the same periods last year consistent with a 36% and 30% increase in simple monthly average assets under management and a shift in the asset mix. SHAREHOLDER SERVICING FEES Shareholder servicing fees are generally fixed charges per shareholder account that vary with the particular type of fund and the service being rendered. In some instances, sponsored investment products are charged these fees based on the level of assets under management. We receive shareholder servicing fees for providing transfer agency services, including providing customer statements, transaction processing, customer service and tax reporting. In the United States, transfer agency service agreements provide that accounts closed in a calendar year generally remain billable through the second quarter of the following calendar year at a reduced rate. In Canada, such agreements provide that accounts closed in the calendar year remain billable for four months after the end of the calendar year. Accordingly, the level of fees will vary with the growth in new accounts and the level of closed accounts that remain billable. In the coming quarter, we anticipate that approximately 549,000 accounts closed in Canada during calendar 2003 will no longer be billable effective May 1, 2004. Shareholder servicing fees increased 12% for the three months ended March 31, 2004 from the same period last year consistent with an increase in billable shareholder accounts. Fees increased 19% for the six months ended March 31, 2004 from the same period last year reflecting increases in fee rates applicable to open accounts, partly reduced by reductions in fee rates chargeable on accounts closed in the prior calendar year, under revised shareholder service fee agreements in the United States that became effective on January 1, 2003, as well as an increase in the overall number of billable shareholder accounts. OTHER, NET Other, net consists primarily of revenues from the banking/finance operating segment and income from custody services. Revenues from the banking/finance operating segment include interest income on loans, servicing income, and investment income on banking/finance investment securities, and are reduced by banking interest expense and the provision for probable loan losses. Other, net increased 13% during the three months ended March 31, 2004 over the same period last year due to realized gains from banking/finance loan portfolio sales and higher servicing fees related to automotive lending, and a decrease in auto lending provision for probable loan losses, partly reduced by a decline in net interest 24 income. The decline in the provision for probable loan losses is related to an increase in loans originated and intended for sale, which are carried at the lower of cost or estimated fair value. Other, net decreased 1% for the six months ended March 31, 2004 compared to the same period last year consistent with lower net interest income, partly offset by higher auto loan serving fees and a decline in the provision for probable loan losses.
OPERATING EXPENSES THREE MONTHS ENDED SIX MONTHS ENDED MARCH 31, PERCENT MARCH 31, PERCENT (in millions) 2004 2003 CHANGE 2004 2003 CHANGE - ---------------------------------------------------------------------------------------------------------- Underwriting and distribution $264.4 $173.1 53% $510.2 $341.9 49% Compensation and benefits 197.1 160.8 23% 386.3 319.9 21% Information systems, technology and occupancy 68.4 71.4 (4%) 138.1 144.0 (4%) Advertising and promotion 31.9 24.2 32% 53.2 46.9 13% Amortization of deferred sales commissions 25.0 17.0 47% 47.4 33.1 43% Amortization of intangible assets 4.4 4.2 5% 8.8 8.5 4% Provision for governmental investigations, proceedings and actions 60.0 -- N/A 60.0 -- N/A September 11, 2001 recovery, net (30.3) -- N/A (30.3) -- N/A Other 28.5 22.7 26% 59.0 45.1 31% - ---------------------------------------------------------------------------------------------------------- TOTAL OPERATING EXPENSES $649.4 $473.4 37% $1,232.7 $939.4 31% - ----------------------------------------------------------------------------------------------------------
UNDERWRITING AND DISTRIBUTION Underwriting and distribution includes amounts payable to brokers and other third parties for selling, distributing and providing ongoing services to investors in our sponsored investment products. Underwriting and distribution expense increased 53% and 49% for the three and six months ended March 31, 2004 over the same periods last year consistent with higher gross sales and assets under management and is similar to the trends in underwriting and distribution revenue. COMPENSATION AND BENEFITS Compensation and benefits expense increased 23% and 21% for the three and six months ended March 31, 2004 compared to the same periods last year. The increase resulted primarily from an increase in bonus expense under the Annual Incentive Compensation Plan, which awards cash and stock bonuses based, in part, on our performance. In addition, merit salary increases effective in October 2003 and additional compensation and benefit costs related to the acquisition of Darby in October 2003 increased costs in fiscal 2004. The increase was partly reduced by the decline of contractual commitments related to the acquisition of Fiduciary Trust Company International ("Fiduciary Trust") in April 2001, as cash payout obligations under the employee retention and transition compensation program were fulfilled as required within two years from the acquisition date. We employed approximately 6,500 people at March 31, 2004 as compared to about 6,600 at March 31, 2003. INFORMATION SYSTEMS, TECHNOLOGY AND OCCUPANCY Information systems, technology and occupancy costs decreased 4% during the three and six months ended March 31, 2004 from the same periods last year primarily due to lower depreciation levels for equipment and software. The decrease in depreciation expense is related to a decrease in purchases of information system and technology equipment as certain of our technology equipment is periodically replaced with new equipment under our technology outsourcing agreement, as well as a stabilization in the number and the scope of new technology project initiatives. 25 Details of capitalized information systems and technology costs were as follows: THREE MONTHS ENDED SIX MONTHS ENDED MARCH 31, MARCH 31, (in thousands) 2004 2003 2004 2003 - ----------------------------------------------------------------------------------------------------- Net book value at beginning of period $73,767 $110,045 $79,126 $121,486 Additions during period, net of disposals and other adjustments 2,741 8,414 10,345 15,331 Amortization during period (11,698) (18,365) (24,661) (36,723) - ----------------------------------------------------------------------------------------------------- NET BOOK VALUE AT END OF PERIOD $64,810 $100,094 $64,810 $100,094 - -----------------------------------------------------------------------------------------------------
ADVERTISING AND PROMOTION Advertising and promotion expense increased 32% and 13% for the three and six months ended March 31, 2004 over the same periods last year due to higher expenditures on direct advertising campaigns, particularly print and television ads, and higher directed brokerage costs. We are committed to invest in advertising and promotion in response to changing business conditions, which means that the level of advertising and promotion expenditures may increase more rapidly or decrease more slowly than our revenues. PROVISION FOR GOVERNMENTAL INVESTIGATIONS, PROCEEDINGS AND ACTIONS In the three months ended March 31, 2004, we recognized a charge to income of $60.0 million ($45.6 million, net of taxes), which represents the costs that can be currently estimated related to ongoing governmental investigations. See also Risk Factors below. SEPTEMBER 11, 2001 RECOVERY, NET In January 2004, we received $32.5 million from our insurance carrier for claims related to the September 11, 2001 terrorist attacks that destroyed Fiduciary Trust's headquarters. These proceeds represented final recoveries for claims submitted to our insurance carrier. We realized a gain of $30.3 million, before income taxes of $12.0 million, as remaining contingencies related to our insurance claims have been resolved. AMORTIZATION OF DEFERRED SALES COMMISSIONS Certain fund share classes are sold without a front-end sales charge to shareholders, although our distribution subsidiaries pay a commission on the sale. In the United States, Class A shares are sold without a front-end sales charge to shareholders when minimum investment criteria are met. However, our U.S. distribution subsidiary pays a commission on these sales. Class B and, effective January 1, 2004, Class C shares are sold without front-end sales charges. Prior to this date, Class C shares were sold with a front-end sales charge that was lower than the commission paid by the U.S. distributor. We record deferred sales commissions assets for these up-front commissions paid by our distribution subsidiaries and amortize them over 12 months to 8 years depending on share class or financing arrangements. We have arranged to finance our Class B and C deferred commission assets ("DCA") arising from our U.S., Canadian and European operations through Lightning Finance Company Limited ("LFL"), a company in which we have a 49% ownership interest. In the United States, LFL has entered into a financing agreement with our U.S. distribution subsidiary and we maintain a continuing interest in the DCA transferred to LFL until resold by LFL. As a result, we reflect DCA sold to LFL under the U.S. agreement on our balance sheet and amortize them over an 8-year period, or until sold by LFL to third parties. In contrast to the U.S. arrangement, LFL has entered into agreements directly with our Canadian and European sponsored investment products, and, as a result, we do not record DCA from these sources in our financial statements. Amortization of deferred sales commissions increased 47% and 43% for the three and six months ended March 31, 2004 over the same periods last year consistent with increased gross product sales and because LFL has not sold U.S. DCA in a securitization transaction since June 2002. 26 OTHER INCOME (EXPENSE) Other income (expense) includes net realized and unrealized investment gains (losses) of consolidated sponsored investment products, investment and other income and interest expense. Investment and other income is comprised primarily of dividends, interest income and realized gains and losses from investments, income from investments accounted for using the equity method of accounting, minority interest expense, and foreign currency exchange gains and losses. Other income (expense) increased 115% and 84% during the three and six months ended March 31, 2004 from the same periods last year. This was primarily due to the inclusion of realized and unrealized gains (losses), net, related to sponsored investment products, higher net realized gains on investments and income from investments accounted for using the equity method of accounting. The increase was partially reduced by an increase in interest expense related to the issuance of five-year senior notes in April 2003, minority interest expense related to the consolidation of sponsored investment products and a decline in net foreign currency exchange gains. TAXES ON INCOME As a multi-national corporation, we provide investment management services to a wide range of international sponsored investment products, often managed from jurisdictions outside the United States. Some of these jurisdictions have lower tax rates than the United States. The mix of income (primarily investment management fees) subject to these lower tax rates, when aggregated with income originating in the United States, produces a lower overall effective tax rate than existing U.S. Federal and state tax rates. Our effective income tax rate for the three and six months ended March 31, 2004 increased to 31% and 30% compared to 28% and 27% for the same periods last year. The increase is due to a shift in the mix of pre-tax income earned in various worldwide jurisdictions, as well as the effect on our tax rate of the $30.3 million insurance recovery and the $60.0 million provision for governmental investigations, proceedings and actions that were recognized in the quarter ended March 31, 2004. The effective tax rate will continue to reflect the relative contributions of foreign earnings that are subject to reduced tax rates and that are not currently included in U.S. taxable income, as well as other factors. MATERIAL CHANGES IN FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES At March 31, 2004, we had $2,549.6 million in cash and cash equivalents, as compared to $1,053.7 million at September 30, 2003. Cash and cash equivalents include cash, U.S. Treasury bills and other debt instruments with maturities of three months or less from the purchase date and other highly liquid investments that are readily convertible into cash, including money market funds. Liquid assets, which consist of cash and cash equivalents, investments (trading and available-for-sale) and current receivables increased to $3,488.8 million at March 31, 2004 from $3,272.3 million at September 30, 2003 primarily due to cash provided by operating activities and proceeds received from auto loan securitizations. During the three months ended March 31, 2004, we had a significant number of U.S. Treasury bills with maturities of greater than three months from the purchase date classified as investment securities, available-for-sale mature. Proceeds from these maturities were invested in other debt instruments classified as cash and cash equivalents, primarily term deposits, with maturities of three months or less from the purchase date, resulting in an increase in cash and cash equivalents and a decrease in investment securities, available-for-sale. Outstanding debt, including Federal Home Loan Bank advances and current maturities of long-term debt, increased to $1,334.7 million at March 31, 2004 compared to $1,123.7 million at September 30, 2003. The balance at March 31, 2004 included $525.2 million in principal and accrued interest related to outstanding convertible notes, $420.0 million in five-year senior notes, a $164.9 million five-year facility, and $212.6 million of other long-term debt, consisting primarily of a long-term financing liability recognized in relation to U.S. DCA financed by LFL that had not yet been sold by LFL in a securitization transaction. As of September 30, 2003, outstanding debt included $520.3 million related to the convertible notes, $420.0 million in five-year senior notes, and $168.8 million in other long-term debt, including current maturities. The increase in outstanding debt from September 30, 2003, is due primarily to the $164.9 million five-year facility used to finance the construction of our corporate headquarters campus, which was consolidated in our financial statements in December 2003 in accordance with the guidance of FASB Interpretation No. 46, "Consolidation of Variable Interest Entities (revised December 2003)". The facility expires in September 2004 and will continue to be classified as a current liability until it is refinanced or repaid. 27 In May 2001, we received approximately $490.0 million in net proceeds from the sale of $877.0 million principal amount at maturity of zero-coupon convertible senior notes due 2031 (the "Convertible Notes"). The Convertible Notes, which were offered to qualified institutional buyers only, carry an interest rate of 1.875% per annum, with an initial conversion premium of 43%. Each of the $1,000 (principal amount at maturity) Convertible Notes is convertible into 9.3604 shares of our common stock, when the price of our stock reaches certain thresholds. We may redeem the Convertible Notes for cash on or after May 11, 2006 at their accreted value. We may have to make additional repurchases, at the option of the holders, on May 11 of 2004, 2006, 2011, 2016, 2021 and 2026. In this event, we may choose to repay the accreted value of the Convertible Notes in cash or shares of our common stock. We have announced our intention to repay the accreted value of the Convertible Notes in cash for any Convertible Notes redeemed on the May 11, 2004 purchase option date. The amount that will be redeemed by the holders, depends on, among other factors, the performance of our common stock. As of March 31, 2004, we had $500.0 million of commercial paper and $300.0 million of debt and equity securities available to be issued under shelf registration statements filed with the SEC. Our committed revolving credit facilities at March 31, 2004 totaled $420.0 million, of which, $210.0 million was under a 364-day facility expiring in June 2004. The remaining $210.0 million facility is under a five-year facility that will expire in June 2007. In addition, at March 31, 2004, our banking/finance operating segment had $546.0 million in available uncommitted short-term bank lines under the Federal Reserve Funds system, the Federal Reserve Bank discount window, and Federal Home Loan Bank short-term borrowing capacity. Our ability to access the capital markets in a timely manner depends on a number of factors including our credit rating, the condition of the global economy, investors' willingness to purchase our securities, interest rates, credit spreads and the valuation levels of equity markets. In extreme circumstances, we might not be able to access this liquidity readily. Our banking/finance operating segment periodically enters into auto loan securitization transactions with qualified special purpose entities, which then issue asset-backed securities to private investors. Gross sales proceeds from these transactions were $46.7 million and $231.8 million for the three and six months ended March 31, 2004 and $0 and $131.6 million for the three and six months ended March 31, 2003. Our ability to access the securitization market will directly affect our plans to finance the auto loan portfolio in the future. The sales commissions that we have financed globally through LFL during the three and six months ended March 31, 2004 were approximately $46.9 million and $90.2 million compared to $36.2 million and $68.3 million over the same periods last year. LFL's ability to access credit facilities and the securitization market will directly affect our existing financing arrangements. We expect that the main uses of cash will be to: * expand our core business * make strategic acquisitions * acquire shares of our common stock * fund property and equipment purchases * pay operating expenses of the business * enhance our technology infrastructure * improve our business processes * pay shareholder dividends * repay and service debt. We believe that we can meet our present and reasonably foreseeable operating cash needs and future commitments through the following: * existing liquid assets * continuing cash flow from operations * borrowing capacity under current credit facilities * ability to issue debt or equity securities * mutual fund sales commission financing arrangements. 28 In particular, we expect to finance future investment in our banking/finance activities through operating cash flows, debt, increased deposit base, or through the securitization of a portion of the receivables from consumer lending activities. CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS In relation to the auto loan securitization transactions that we have entered into with a number of qualified special purpose entities, we are obligated to cover shortfalls in amounts due to the holders of the notes up to certain levels as specified under the related agreements. As of March 31, 2004, the maximum potential amount of future payments was $18.0 million relating to guarantees made prior to January 1, 2003. In addition, our consolidated balance sheet at March 31, 2004 included a $0.3 million liability to reflect obligations arising from auto securitization transactions subsequent to December 31, 2002. At March 31, 2004, the banking/finance operating segment had commitments to extend credit aggregating $262.7 million, primarily under its credit card lines, and had issued financial standby letters of credit totaling $2.5 million on which beneficiaries would be able to draw upon in the event of non-performance by our customers, primarily in relation to lease and lien obligations of these banking customers. These standby letters of credit, issued prior to January 1, 2003, were secured by marketable securities with a fair value of $3.2 million as of March 31, 2004 and commercial real estate. In July 2003, we renegotiated an agreement to outsource management of our data center and distributed server operations, originally signed in February 2001. We may terminate the amended agreement any time after July 1, 2006 by incurring a termination charge. The maximum termination charge payable will depend on the termination date of the amended agreement, the service levels before our termination of the agreement, costs incurred by our service provider to wind-down the services and costs associated with assuming equipment leases. As of March 31, 2004, we estimate that the termination fee payable in July 2006, not including costs associated with assuming equipment leases, would approximate $14.0 million and would decrease each month for the subsequent two years, reaching a payment of approximately $2.2 million in July 2008. We lease office space and equipment under long-term operating leases. As of March 31, 2004, there were no material changes in leasing arrangements that would have a significant effect on future minimum lease payments reported in our Annual Report on Form 10-K for the period ended September 30, 2003. OFF-BALANCE SHEET ARRANGEMENTS As discussed above, we obtain financing for sales commissions that we pay to brokers on Class B and C shares through LFL, a company incorporated in Ireland whose sole business purpose is to finance our DCA. We hold a 49% ownership interest in LFL and we account for this ownership interest using the equity method of accounting. In addition, we retain U.S.-originated DCA and related long-term debt in our financial statements until resold by LFL in a securitization transaction with third parties. Our exposure to loss related to our investment in LFL is limited to the carrying value of our investment in and loans to LFL, and interest and fees receivable from LFL. At March 31, 2004, those amounts approximated $52.6 million. During the six months ended March 31, 2004, we financed approximately $90.2 million of sales commissions through LFL and we recognized a pre-tax charge of approximately $2.1 million for our share of its net loss over this period. As discussed above, our banking/finance operating segment periodically enters into auto loan securitization transactions with qualified special purpose entities, which then issue asset-backed securities to private investors. Our main objective in entering in securitization transactions is to obtain financing for auto loan activities. Securitized loans held by the securitization trusts totaled $719.0 million as of March 31, 2004 and $680.7 million at September 30, 2003. In October 1999, we entered into an agreement for the lease of our corporate headquarters campus in San Mateo, California from a lessor trust under an operating lease that expires in fiscal 2005, with additional renewal options for a further period of up to 10 years. In connection with this lease, we are contingently liable for approximately $145.0 million in residual guarantees representing about 85% of the total construction costs of $170.0 million. We are also contingently liable to purchase the corporate headquarters campus for an amount equal to the final construction costs of $170.0 million if an event of default occurs under the agreement. An event of default includes, but is not limited to, failure to make lease payments when due and failure to maintain required insurance. Management considers the possibility of default under the provisions of the agreement to be remote. 29 On December 31, 2003, we consolidated the lessor trust under the provisions of the Financial Accounting Standards Board ("FASB") Interpretation No. 46, "Consolidation of Variable Interest Entities (revised December 2003)" ("FIN 46-R") and recognized, as a current liability, the loan principal of $164.9 million and minority interest of $5.1 million, which, in total, represent the amount used to finance the construction of our corporate headquarters campus and our maximum contingent liability under the agreements. CRITICAL ACCOUNTING POLICIES Our financial statements and accompanying notes are prepared in accordance with generally accepted accounting principles in the United States. The preparation of these financial statements requires us to make estimates and assumptions that impact our financial position and results of operations. These estimates and assumptions are affected by our application of accounting policies. Below we describe certain critical accounting policies that we believe are important to understanding our results of operations and financial position. For additional information about our accounting policies, please refer to Note 1 to the financial statements contained in our Annual Report on Form 10-K for the fiscal year ended September 30, 2003. GOODWILL AND OTHER INTANGIBLE ASSETS Under Statement of Financial Accounting Standards No. 142 "Goodwill and Other Intangible Assets", we are required to test the fair value of goodwill and indefinite-lived intangibles when there is an indication of impairment, or at least once a year. During the quarter ended March 31, 2004, we completed our annual impairment test of goodwill and indefinite-lived intangible assets and we determined that there was no impairment to these assets as of October 1, 2003. The fair value of indefinite-lived intangible assets is determined based on anticipated discounted cash flows. An indication of goodwill impairment occurs when the carrying amount of the reporting unit exceeds the implied fair value of the reporting unit. In estimating the fair value of the reporting unit, we use valuation techniques based on discounted cash flows similar to models employed in analyzing the purchase price of an acquisition target. Intangible assets subject to amortization are reviewed for circumstances that may indicate impairment at each reporting period on the basis of the expected future undiscounted operating cash flows, without interest charges, to be derived from these assets. In performing our analysis, we used certain assumptions and estimates including those related to discount rates and the expected future period of cash flows to be derived from the assets, based on, among other factors, historical trends and the characteristics of the assets. While we believe that our testing was appropriate, if these estimates and assumptions change in the future, we may be required to record impairment charges or otherwise increase amortization expense. INCOME TAXES As a multinational corporation, we operate in various locations outside the United States. We have not made a provision for U.S. taxes on the cumulative undistributed earnings of foreign subsidiaries as those earnings are intended to be reinvested for an indefinite period of time. These earnings approximated $2.3 billion at March 31, 2004. Changes to our policy of reinvesting foreign earnings may have a significant effect on our financial condition and results of operation. VALUATION OF INVESTMENTS We record substantially all investments in our financial statements at fair value or amounts that approximate fair value. Where available, we use prices from independent sources such as listed market prices or broker or dealer price quotations. For investments in illiquid and privately held securities that do not have readily determinable fair values, we estimate the value of the securities based upon available information. However, even where the value of a security is derived from an independent market price or broker or dealer quote, some assumptions may be required to determine the fair value. For example, we generally assume that the size of positions in securities that we hold would not be large enough to affect the quoted price of the securities when sold, and that any such sale would happen in an orderly manner. However, these assumptions may be incorrect and the actual value realized on sale could differ from the current carrying value. We evaluate our investments available-for-sale for other-than-temporary decline in value on a periodic basis. This may exist when the fair value of an investment has been below the current value for an extended period of 30 time. As most of our investments are carried at fair value, if an other-than-temporary decline in value is determined to exist, the unrealized investment loss recorded net of tax in accumulated other comprehensive income is realized as a charge to net income, in the period in which the other-than-temporary decline in value would be determined. While we believe that we have accurately estimated the amount of other-than-temporary decline in value in our portfolio, different assumptions could result in changes to the recorded amounts in our financial statements. Investment securities, trading are carried at fair value with changes in fair value recognized in our consolidated net income. Trading securities are comprised of securities held by majority-owned sponsored investment products that have been consolidated in our financial statements. LOSS CONTINGENCIES We are involved in various lawsuits and claims encountered in the normal course of business. When such a matter arises and periodically thereafter, we consult with our legal counsel and evaluate the merits of the claim based on the facts available at that time. In management's opinion, an adequate accrual has been made as of March 31, 2004 to provide for any probable losses that may arise from these matters (see also Risk Factors below). VARIABLE INTEREST ENTITIES Under the FASB FIN 46-R, a variable interest entity ("VIE") is an entity in which the equity investment holders have not contributed sufficient capital to finance the activities of the VIE or the equity investment holders do not have defined rights and obligations normally associated with an equity investment. FIN 46-R requires consolidation of a VIE by the enterprise that has the majority of the risks and rewards of ownership, referred to as the primary beneficiary. Evaluating whether related entities are VIEs and determining whether we qualify as the primary beneficiary of these VIEs, is highly complex and involves the use of estimates and assumptions. In general, when we estimate the expected residual returns of a VIE based on discounted cash flows, we make certain assumptions about discount rates. In addition, we determine the volatility of the VIE's expected returns based on available historical information and management's estimates. While we believe that our testing and approach were appropriate, future changes in estimates and assumptions may affect our decision to consolidate one or more VIEs in our financial statements. RISK FACTORS WE FACE STRONG COMPETITION FROM NUMEROUS AND SOMETIMES LARGER COMPANIES. We compete with numerous investment management companies, stock brokerage and investment banking firms, insurance companies, banks, savings and loan associations and other financial institutions. Continuing consolidation in the financial services industry has created stronger competitors with greater financial resources and broader distribution channels than our own. Additionally, competing securities dealers whom we rely upon to distribute our mutual funds also sell their own proprietary funds and investment products, which could limit the distribution of our investment products. To the extent that existing or potential customers, including securities dealers, decide to invest in or distribute the products of our competitors, the sales of our products as well as our market share, revenues and net income could decline. CHANGES IN THE DISTRIBUTION CHANNELS ON WHICH WE DEPEND COULD REDUCE OUR REVENUES AND HINDER OUR GROWTH. We derive nearly all of our fund sales through broker/dealers and other similar investment advisors. Increasing competition for these distribution channels has caused our distribution costs to rise and could cause further increases in the future. Higher distribution costs lower our net revenues and earnings. Additionally, if one of the major financial advisors who distribute our products were to cease their operations, it could have a significant adverse impact on our revenues and earnings. Moreover, our failure to maintain strong business relationships with these advisors would impair our ability to distribute and sell our products, which would have a negative effect on our level of assets under management, related revenues and overall business and financial condition. WE HAVE BECOME SUBJECT TO AN INCREASED RISK OF VOLATILITY OF THE ASSETS WE MANAGE CAUSED BY CHANGES IN THE GLOBAL EQUITY MARKETS. We have become subject to an increased risk of asset volatility from changes in the 31 domestic and global financial and equity markets due to the continuing threat of terrorism. Declines in these markets have caused in the past, and would cause in the future, a decline in our revenue and income. THE LEVELS OF OUR ASSETS UNDER MANAGEMENT, WHICH IN TURN IMPACT REVENUES, ARE SUBJECT TO SIGNIFICANT FLUCTUATIONS. Global economic conditions, changes in the equity market place, interest rates, inflation rates, the yield curve and other factors that are difficult to predict affect the mix, market values and levels of our assets under management. Changing market conditions may cause a shift in our asset mix towards fixed-income products and a related decline in our revenue and income, since we generally derive higher fee revenues and income from equity assets than from fixed-income products we manage. Similarly, our securitized consumer receivables business is subject to marketplace fluctuation, including economic and credit market downturns. WE FACE RISKS ASSOCIATED WITH CONDUCTING OPERATIONS IN NUMEROUS FOREIGN COUNTRIES. We sell mutual funds and offer investment advisory and related services in many different regulatory jurisdictions around the world, and intend to continue to expand our operations internationally. Regulators in these jurisdictions could change their policies or laws in a manner that might restrict or otherwise impede our ability to distribute or register investment products in their respective markets. OUR ABILITY TO SUCCESSFULLY INTEGRATE WIDELY VARIED BUSINESS LINES CAN BE IMPEDED BY SYSTEMS AND OTHER TECHNOLOGICAL LIMITATIONS. Our continued success in effectively managing and growing our business both domestically and abroad, depends on our ability to integrate the varied accounting, financial, information and operational systems of our various businesses on a global basis. OUR INABILITY TO MEET CASH NEEDS COULD HAVE A NEGATIVE EFFECT ON OUR FINANCIAL CONDITION AND BUSINESS OPERATIONS. Our ability to meet anticipated cash needs depends upon factors including our asset value, our creditworthiness as perceived by lenders and the market value of our stock. Similarly, our ability to securitize and hedge future loan portfolios and credit card receivables, and to obtain continued financing for Class B and C shares, is also subject to the market's perception of those assets, finance rates offered by competitors, and the general market for private debt. If we are unable to obtain these funds and financing, we may be forced to incur unanticipated costs or revise our business plans. CERTAIN OF THE PORTFOLIOS WE MANAGE INCLUDING OUR EMERGING MARKET PORTFOLIOS AND RELATED REVENUES ARE VULNERABLE TO MARKET-SPECIFIC POLITICAL OR ECONOMIC RISKS. Our emerging market portfolios and revenues derived from managing these portfolios are subject to significant risks of loss from political and diplomatic developments, currency fluctuations, social instability, changes in governmental polices, expropriation, nationalization, asset confiscation and changes in legislation related to foreign ownership. Foreign trading markets, particularly in some emerging market countries are often smaller, less liquid, less regulated and significantly more volatile than the U.S. and other established markets. DIVERSE AND STRONG COMPETITION LIMITS THE INTEREST RATES THAT WE CAN CHARGE ON CONSUMER LOANS. We compete with many types of institutions for consumer loans, which can provide loans at significantly below-market interest rates in connection with automobile sales or in some cases zero interest rates. Our inability to compete effectively against these companies or to maintain our relationships with the various automobile dealers through whom we offer consumer loans could limit the growth of our consumer loan business. Economic and credit market downturns could reduce the ability of our customers to repay loans, which could cause our consumer loan portfolio losses to increase. WE ARE SUBJECT TO FEDERAL RESERVE BOARD REGULATION. Upon completion of our acquisition of Fiduciary Trust in April 2001, we became a bank holding company and a financial holding company subject to the supervision and regulation of the Federal Reserve Board. We are subject to the restrictions, limitations, or prohibitions of the Bank Holding Company Act of 1956 and the Gramm-Leach-Bliley Act. The Federal Reserve Board may impose additional limitations or restrictions on our activities, including if the Federal Reserve Board believes that we do not have the appropriate financial and managerial resources to commence or conduct an activity or make an acquisition. TECHNOLOGY AND OPERATING RISK COULD CONSTRAIN OUR OPERATIONS. We are highly dependent on the integrity of our technology, operating systems and premises. Although we have in place certain disaster recovery plans, we 32 may experience system delays and interruptions as a result of natural disasters, power failures, acts of war, and third party failures, which could negatively impact our operations. GOVERNMENTAL INVESTIGATIONS, ONGOING AND PROPOSED GOVERNMENTAL ACTIONS, AND REGULATORY EXAMINATIONS OF THE COMPANY AND ITS BUSINESS ACTIVITIES AS WELL AS CIVIL LITIGATION ARISING OUT OF OR RELATED TO SUCH MATTERS, COULD ADVERSELY IMPACT OUR ASSETS UNDER MANAGEMENT, INCREASE COSTS AND NEGATIVELY IMPACT THE PROFITABILITY OF THE COMPANY AND FUTURE FINANCIAL RESULTS. MASSACHUSETTS ADMINISTRATIVE PROCEEDING. On February 4, 2004, the Securities Division of the Office of the Secretary of the Commonwealth of Massachusetts filed an administrative complaint against Franklin Resources, Inc. and certain of its subsidiaries (the "Company") claiming violations of the Massachusetts Uniform Securities Act ("Massachusetts Act") with respect to an alleged arrangement to permit market timing (the "Mass Proceeding"). On February 14, 2004, the Company filed an answer denying all violations of the Massachusetts Act. GOVERNMENTAL INVESTIGATIONS. As part of ongoing investigations by the SEC, the U.S. Attorney for the Northern District of California, the New York Attorney General, the California Attorney General, the U.S. Attorney for the District of Massachusetts, the Florida Department of Financial Services and the Commissioner of Securities, the West Virginia Attorney General and the Vermont Department of Banking, Insurance, Securities, and Health Care Administration, relating to certain practices in the mutual fund industry, including late trading, market timing and payments to securities dealers who sell fund shares, the Company and its subsidiaries, as well as certain current or former executives and employees of the Company, have received requests for information and/or subpoenas to testify or produce documents. The Company and its current employees are providing documents and information in response to these requests and subpoenas. In addition, the Company has responded to requests for similar kinds of information from regulatory authorities in some of the foreign countries where the Company conducts its global asset management business. The staff of the SEC has informed the Company that it intends to recommend that the SEC authorize a civil injunctive action against Franklin Advisers, Inc., a subsidiary of the Company. The SEC's investigation is focused on the activities that are the subject of the Mass Proceeding described above and other instances of alleged market timing by a limited number of third parties that ended in 2000. The Company currently believes that the charges the SEC staff is contemplating are unwarranted. There are discussions underway with the SEC staff in an effort to resolve the issues raised in their investigation and, although there can be no assurance, a resolution of such issues may be reached with the SEC staff in the coming quarter. In the three months ended March 31, 2004, the Company recorded a charge to income of $60 million, which represents the costs that can be currently estimated related to ongoing governmental investigations, proceedings and actions. Separately, in response to requests for information and subpoenas from the SEC and the California Attorney General, the Company has provided documents and testimony has been taken relating to payments to securities dealers who sell shares of the Franklin, Templeton and Mutual Series U.S. Funds (each a "Fund" and together, "Funds"). Effective November 28, 2003, the Company determined not to direct any further brokerage commissions where the allocation is based, not only on best execution, but also on the sale of Fund shares, which determination may have an adverse impact on the Company. INTERNAL INQUIRIES. The Company also has conducted its own internal fact-finding inquiry with the assistance of outside counsel to determine whether any shareholders of the Funds, including Company employees, were permitted to engage in late trading or in market timing transactions contrary to the policies of the affected Fund and, if so, the circumstances and persons involved. The Company's internal inquiry regarding market timing and late trading is substantially complete. We have not found any late trading problems, but we have identified various instances of frequent trading. One officer of a subsidiary of the Company had been placed on administrative leave and subsequently resigned from his position with the Company. As previously disclosed, the Company also has identified some instances of frequent trading in shares of certain Funds by a few current or former employees in their personal 401(k) plan accounts. These individuals included one trader and one officer of the Funds. Pending our further inquiry, these two individuals were placed on administrative leave and the officer resigned from his positions with the Funds. We have found no instances of inappropriate mutual fund trading by any portfolio manager, investment analyst or officer of Franklin Resources, Inc. The independent directors of the Funds and the Company also retained independent outside counsel to review these matters and to report their findings and recommendations. Based on independent 33 counsel's findings and recommendations, the Company has reinstated the trader. The independent counsel has concluded that some instances of the former Fund officer's trading violated Company policy and recommended appropriate disciplinary action. The former Fund officer has subsequently resigned as an employee of the Company. The Company does not believe there were any losses to the Funds as a result of this trading. CLASS ACTION AND OTHER LAWSUITS. The Company has been named in shareholder class and other actions related to some of the matters described above. See "Legal Proceedings" included in Part II, Item 1 of this report. Management believes that the claims made in the lawsuits are without merit and intends to vigorously defend against them. It is anticipated that the Company may be named in additional similar civil actions related to some of the matters described above. REGULATORY OR LEGISLATIVE ACTIONS AND REFORMS, PARTICULARLY THOSE SPECIFICALLY FOCUSED ON THE MUTUAL FUND INDUSTRY, COULD ADVERSELY IMPACT OUR ASSETS UNDER MANAGEMENT, INCREASE COSTS AND NEGATIVELY IMPACT THE PROFITABILITY OF THE COMPANY AND FUTURE FINANCIAL RESULTS. Various compliance and disclosure requirements and procedures focused on the mutual fund industry have been adopted, proposed or are being considered by, among others, the SEC and Congress. These new or anticipated actions or reforms may increase costs and could have an adverse effect on our future financial results. 34 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK In the normal course of business, our financial position is subject to market risk: the potential loss due to changes in the value of investments resulting from adverse changes in interest rates, foreign exchange and/or equity prices. Management is responsible for managing this risk. Our Enterprise Risk Management Committee is responsible for providing a framework to assist management to identify, assess and manage market and other risks. We are exposed to changes in interest rates primarily through financing transactions and portfolio debt holdings available-for-sale, which are carried at fair value in our financial statements. As of March 31, 2004, a significant percentage of our outstanding debt was at fixed interest rates. In our banking/finance operating segment, we monitor the net interest rate margin and the average maturity of interest earning assets, as well as funding sources. In addition, as of March 31, 2004, we have considered the potential impact of the effect on the banking/finance operating segment balances, our outstanding debt and portfolio debt holdings, individually and collectively, of a 100 basis point (1%) movement in market interest rates. Based on our analysis, we do not expect that this change would have a material impact on our operating revenues or results of operations in either scenario. We operate primarily in the United States, but also provide services and earn revenues in Canada, the Bahamas, Europe, Asia, South America, Africa and Australia. A significant portion of these revenues and associated expenses, however, are denominated in U.S. dollars. Therefore, our exposure to foreign currency fluctuations in our revenues and expenses is not material at this time. This situation may change in the future as our business continues to grow outside the United States. We are also exposed to equity price fluctuations through securities we hold that are carried at fair value. To mitigate this risk, we maintain a diversified investment portfolio. ITEM 4. CONTROLS AND PROCEDURES The Company's management evaluated, with the participation of the Company's principal executive and principal financial officers, the effectiveness of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of March 31, 2004. Based on their evaluation, the Company's principal executive and principal financial officers concluded that the Company's disclosure controls and procedures were effective as of March 31, 2004. There has been no change in the Company's internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the Company's fiscal quarter ended March 31, 2004, that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS As previously reported, on February 4, 2004, the Securities Division of the Office of the Secretary of the Commonwealth of Massachusetts filed an administrative complaint against Franklin Resources, Inc. and certain of its subsidiaries (the "Company") claiming violations of the Massachusetts Uniform Securities Act ("Massachusetts Act") with respect to an alleged arrangement to permit market timing (the "Mass Proceeding"). On February 14, 2004, the Company filed an answer denying all violations of the Massachusetts Act. In addition, the Company and certain of its subsidiaries and current and former officers, employees, and directors have been named in multiple lawsuits in different federal courts in Nevada, California, Illinois, New York, New Jersey, and Florida, alleging violations of various federal securities laws and seeking, among other things, monetary damages and costs. Specifically, the lawsuits claim breach of duty with respect to alleged arrangements to permit market timing and/or late trading activity, or breach of duty with respect to the valuation of the portfolio securities of certain Templeton funds managed by Company subsidiaries, resulting in alleged market timing activity. The majority of these lawsuits duplicate, in whole or in part, the allegations asserted in the Mass Proceeding detailed above. The lawsuits are styled as class actions or derivative actions on behalf of either the named Funds or the Company. 35 Management strongly believes that the claims made in each of these lawsuits, as more specifically described below, are without merit and intends to vigorously defend against them. To date, more than 240 similar lawsuits against 18 different mutual fund companies have been filed in federal court districts throughout the country. Because these cases involve common questions of fact, the Judicial Panel on Multidistrict Litigation (the "Judicial Panel") ordered the creation of a multidistrict litigation, entitled "In re Mutual Funds Investment Litigation," and transferred similar cases from different districts to a single district (the United States District Court for the District of Maryland) for coordinated or consolidated pretrial proceedings (the "MDL"). As of May 12, 2004, the following lawsuits are pending against the Company and have been transferred or conditionally transferred to the MDL: Kenerley v. Templeton Funds, Inc., et al., Case No. 03-770 GPM, filed on November 19, 2003 in the United States District Court for the Southern District of Illinois; Cullen v. Templeton Growth Fund, Inc., et al., Case No. 03-859 MJR, filed on December 16, 2003 in the United States District Court for the Southern District of Illinois and transferred to the United States District Court for the Southern District of Florida on March 29, 2004; Alexander v. Franklin AGE High Income Fund, et al., Case No. C 04 0639 SC, filed on February 17, 2004 in the United States District Court for the Northern District of California; Jaffe v. Franklin AGE High Income Fund, et al., Case No. CV-S-04-0146-PMP-RJJ, filed on February 6, 2004 in the United States District Court for the District of Nevada; Lum v. Franklin Resources, Inc., et al., Case No. C 04 0583 JSW, filed on February 11, 2004 in the United States District Court for the Northern District of California; Fischbein v. Franklin AGE High Income Fund, et al., Case No. C 04 0584 JSW, filed on February 11, 2004 in the United States District Court for the Northern District of California; Beer v. Franklin AGE High Income Fund, et al., Case No. 8:04-CV-249-T-26 MAP, filed on February 11, 2004 in the United States District Court for the Middle District of Florida; Bennett v. Franklin Resources, Inc., et al., Case No. CV-S-04-0154-HDM-RJJ, filed on February 12, 2004 in the United States District Court for the District of Nevada; Dukes v. Franklin AGE High Income Fund, et al., Case No. C 04 0598 MJJ, filed on February 12, 2004, in the United States District Court for the Northern District of California; McAlvey v. Franklin Resources, Inc., et al., Case No. C 04 0628 PJH, filed on February 13, 2004 in the United States District Court for the Northern District of California; Hugh Sharkey IRA/RO v. Franklin Resources, Inc., et al., Case No. 04 CV 1330, filed on February 18, 2004 in the United States District Court for the Southern District of New York; Hertz v. Burns, et al., Case No. 04 CV 02489, filed on March 30, 2004 in the United States District Court for the Southern District of New York. The Company is awaiting the Judicial Panel's decision whether to transfer to the MDL the following additional federal lawsuits involving similar or identical allegations: D'Alliessi, et al. v. Franklin AGE High Income Fund, et al., Case No. C 04 0865 SC, filed on March 3, 2004 in the United States District Court for the Northern District of California; Marcus v. Franklin Resources, Inc., et al., Case No. C 04 0901 JL, filed on March 5, 2004 in the United States District Court for the Northern District of California; Banner v. Franklin Resources, Inc., et al., Case No. C 04 0902 JL, filed on March 5, 2004 in the United States District Court for the Northern District of California; Denenberg v. Franklin Resources, Inc., et al., Case No. C 04 0984 EMC, filed on March 10, 2004 in the United States District Court for the Northern District of California. Plaintiffs in the MDL proceeding have until May 28, 2004 to file their consolidated complaint(s). As previously reported, various subsidiaries of the Company have also been named in multiple lawsuits filed in state courts in Illinois alleging breach of duty with respect to the valuation of the portfolio securities of certain Templeton funds managed by such subsidiaries and are as follows: Bradfisch v. Templeton Funds, Inc., et al., Case No. 2003 L 001361, filed on October 3, 2003 in the Circuit Court of the Third Judicial Circuit, Madison County, Illinois; Woodbury v. Templeton Global Smaller Companies Fund, Inc., et al., Case No. 2003 L 001362, filed on October 3, 2003 in the Circuit Court of the Third Judicial Circuit, Madison County, Illinois; Kwiatkowski v. Templeton Growth Fund, Inc., et al., Case No. 03 L 785, filed on December 17, 2003 in the Circuit Court for the Twentieth Judicial Circuit, St. Clair County, Illinois; Parise v. Templeton Funds, Inc., et al., Case No. 2003 L 002049, filed on December 22, 2003 in the Circuit Court of the Third Judicial Circuit, Madison County, Illinois. These lawsuits are not subject to the MDL because they are state court actions. 36 In addition, the Company and its subsidiaries, as well as certain current and former officers, employees, and directors, have been named in multiple lawsuits alleging violations of various securities laws and pendent state law claims relating to the disclosure of directed brokerage payments and payment of allegedly excessive commissions and advisory fees. These lawsuits are styled as class actions and derivative actions brought on behalf of certain funds, and are as follows: Stephen Alexander IRA v. Franklin Resources, Inc., et al., Case No. 04-982 (JLL), filed on March 2, 2004 in the United States District Court for the District of New Jersey; Strigliabotti v. Franklin Resources, Inc., et al., Case No. C 04 0883 SI, filed on March 4, 2004 in the United States District Court for the Northern District of California; Tricarico v. Franklin Resources, Inc., et al., Case No. CV-04-1052 (JAP), filed on March 4, 2004 in the United States District Court for the District of New Jersey; Miller v. Franklin Mutual Advisors, LLC, et al., Case No. 04-261 DRH, filed on April 16, 2004 in the United States District Court for the Southern District of Illinois. Please also see the discussion of certain governmental proceedings and investigations in Note 13, "Commitments and Contingencies - Governmental Investigations, Proceedings and Actions", of Notes to Consolidated Financial Statements included in Part I, Item 1 of this report. Except for the matters described above, there have been no material developments in the litigation previously reported in our quarterly report on Form 10-Q for the period ended December 31, 2003, as filed with the SEC on February 17, 2004. We are involved from time to time in litigation relating to claims arising in the normal course of business. Management is of the opinion that the ultimate resolution of such claims will not materially affect our business or financial position. ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES The following table provides information with respect to the shares of common stock we repurchased during the six months ended March 31, 2004: (c) TOTAL NUMBER OF SHARES (d) MAXIMUM PURCHASED AS NUMBER OF SHARES PART OF THAT MAY YET BE (a) TOTAL (b) AVERAGE PUBLICLY PURCHASED UNDER NUMBER OF PRICE PAID PER ANNOUNCED PLANS THE PLANS OR Period SHARES PURCHASED SHARE OR PROGRAMS PROGRAMS - ---------------------------- ----------------- ----------------- ----------------- ------------------ October 1, 2003 through October 31, 2003 198,592 $44.59 198,592 14,378,977 November 1, 2003 through November 30, 2003 7,234 $46.66 7,234 14,371,743 December 1, 2003 through December 31, 2003 70,000 $47.58 70,000 14,301,743 January 1, 2004 through January 31, 2004 8,767 $53.76 8,767 14,292,976 February 1, 2004 through February 29, 2004 21,851 $57.70 21,851 14,271,125 March 1, 2004 through March 31, 2004 7,908 $55.74 7,908 14,263,217 ----------------- ----------------- TOTAL 314,352 314,352
Under a stock repurchase program authorized by our Board of Directors, we can repurchase shares of our common stock on the open market and in private transactions in accordance with applicable securities laws. In August 2002, May 2003, and August 2003, we announced increases in the number of shares available for repurchase under our stock repurchase program totaling 30 million shares, of which, 14.3 million shares remain 37 available for repurchase as of March 31, 2004. Our stock repurchase program is not subject to an expiration date. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Annual Meeting of Stockholders of Franklin Resources, Inc. was held at 10:00 a.m., Pacific Standard Time, on January 29, 2004 at the principal offices of the Company located at One Franklin Parkway, San Mateo, California. The proposals presented and voted upon and the results of the vote were as follows: (a) ELECTION OF DIRECTORS. Each of the eleven nominees for director was elected and received the number of votes set forth below: NAME VOTES FOR VOTES WITHHELD ---- --------- -------------- Harmon E. Burns 198,455,634 3,914,883 Charles Crocker 196,091,660 6,278,857 Robert D. Joffe 201,051,567 1,318,950 Charles B. Johnson 198,520,397 3,850,120 Rupert H. Johnson, Jr. 200,229,666 2,140,851 Thomas H. Kean 194,851,382 7,519,135 James A. McCarthy 192,012,411 10,358,106 Chutta Ratnathicam 192,027,657 10,342,860 Peter M. Sacerdote 196,835,074 5,535,443 Anne M. Tatlock 200,065,044 2,305,473 Louis E. Woodworth 192,006,075 10,364,442 (b) RATIFICATION OF APPOINTMENT OF INDEPENDENT AUDITORS. The ratification of the appointment of PricewaterhouseCoopers LLP as the Company's independent auditors for the fiscal year ending September 30, 2004, was approved by a vote of 188,900,172 shares in favor, 12,249,609 shares against and 1,220,736 shares abstaining. (c) APPROVAL OF THE 2004 KEY EXECUTIVE INCENTIVE COMPENSATION PLAN. The 2004 Key Executive Incentive Compensation Plan was approved by a vote of 179,289,243 shares in favor, 8,978,149 shares against, 1,344,111 shares abstaining and 12,759,014 shares of non-votes. (d) APPROVAL OF THE AMENDED AND RESTATED ANNUAL INCENTIVE COMPENSATION PLAN. The Amended and Restated Annual Incentive Compensation Plan was approved by a vote of 162,780,535 shares in favor, 25,506,060 shares against, 1,324,908 shares abstaining and 12,759,014 shares of non-votes. 38 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: see Exhibit Index on page 41 to page 42. (b) Reports on Form 8-K: (i) On January 22, 2004, we furnished a report on Form 8-K under Item 12 with the SEC attaching our press release dated January 22, 2004 announcing our financial results for the quarter ended December 31, 2003. (ii) On February 9, 2004 we filed a report on Form 8-K under Item 5 with the SEC announcing, among other things, that the Securities Division of Massachusetts filed an administrative complaint against Franklin Resources, Inc. and certain of its subsidiaries (the "Company"), and that the Staff of the SEC intended to recommend that the SEC authorize a civil action against a subsidiary of the Company and two senior officers. (iii)On March 3, 2004, we filed a report on Form 8-K under Item 5 with the SEC announcing that the Staff of the SEC no longer intended to recommend that the SEC authorize a civil action against Gregory E. Johnson, the President and Co-Chief Executive Officer of the Company. 39 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. FRANKLIN RESOURCES, INC. (Registrant) Date: May 14, 2004 By: /S/ JAMES R. BAIO ----------------------- James R. Baio Senior Vice President and Chief Financial Officer 40 EXHIBIT INDEX 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 Amended and Restated By-Laws incorporated by reference to Exhibit 3(ii) to the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 2002. Exhibit 4.1 Indenture between Franklin Resources, Inc. and The Chase Manhattan Bank (formerly Chemical Bank), as trustee, dated as of May 19, 1994, incorporated by reference to the Company's Registration Statement on Form S-3, filed on April 14, 1994. Exhibit 4.2 Indenture between Franklin Resources, Inc. and The Bank of New York dated May 11, 2001 incorporated by reference to Exhibit 4.2 to the Registrant's Registration Statement on Form S-3, filed on August 6, 2001. Exhibit 4.3 Form of Liquid Yield Option Note due 2031 (Zero Coupon- Senior) (included in Exhibit 4.2 to the Registrant's Registration Statement on Form S-3, filed on August 6, 2001). Exhibit 4.4 Registration Rights Agreement between Franklin Resources, Inc. and Merrill Lynch, Pierce, Fenner & Smith Incorporated ("Merrill Lynch") dated May 11, 2001, incorporated by reference to the Registrant's Registration Statement on Form S-3, filed on August 6, 2001. Exhibit 4.5 Form of 3.7% Senior Notes due 2008 incorporated by reference to Exhibit 4.5 to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 2003, filed on May 12, 2003. Exhibit 10.74 Settlement and Release Agreement between Franklin Resources, Inc. and Great Northern Insurance Company dated January 15, 2004. Exhibit 12 Computations of ratios of earnings to fixed charges. Exhibit 31.1 Certification of Co-Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. Exhibit 31.2 Certification of Co-Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. Exhibit 31.3 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. Exhibit 32.1 Certification of Co-Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished herewith). Exhibit 32.2 Certification of Co-Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished herewith). 41 Exhibit 32.3 Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished herewith). 42 EX-10 2 exh10-74_notconfid.txt SETTLEMENT AGREEMENT EXHIBIT 10.74 ------------- SETTLEMENT AND RELEASE AGREEMENT This Settlement and Release Agreement (the "Agreement") is made this 15th day of January, 2004, by and between Franklin Resources, Inc. and its affiliated, subsidiary, and associated companies and/or corporations, including their interests in joint ventures as now exist or may hereafter be constituted or acquired ("FRANKLIN") and Great Northern Insurance Company ("Great Northern"). FRANKLIN and Great Northern are individually referred to herein as a "Party," and collectively they are referred to herein as the "Parties." RECITALS WHEREAS, Great Northern issued to FRANKLIN an insurance policy, No. 3533-87-15, effective from November 1, 2000 to November 1, 2001 (the "Policy"); WHEREAS, on or about September 13, 2001, FRANKLIN notified Great Northern of a claim under the Policy for losses suffered as a result of the September 11, 2001 attack on the World Trade Center (the "9-11 Claim"); WHEREAS, a dispute has arisen between the Parties concerning the scope of coverage provided under the Policy and the amounts payable under the Policy with respect to FRANKLIN's 9-11 claim (the "Dispute over FRANKLIN's 9-11 Claim under Great Northern Policy No. 3533-87-15 "); WHEREAS, the Parties have now agreed to compromise and settle all controversies between them concerning or arising out of the Dispute over FRANKLIN's 9-11 claim, without any Party admitting any liability to any other Party, on the terms set forth herein for a total payment of $100,000,000.00. NOW, THEREFORE, IT IS HEREBY STIPULATED AND AGREED, BY and between the undersigned, that: 1. PAYMENT. Great Northern has previously made partial payments to FRANKLIN for the 9-11 Claim totaling $67,513,130.59, receipt of which FRANKLIN hereby acknowledges. A final payment of $32,486,869.41 is thus required. 2. Within five (5) business days following the execution of this Agreement by the Parties (the "Effective Date"), and in exchange for the consideration provided herein (and as a condition to such consideration), Great Northern shall make a final monetary payment to FRANKLIN in the amount of $32,486,869.41 by check payable to FRANKLIN. This payment shall be made in full satisfaction of Great Northern's financial obligations under this Agreement. 3. RELEASE. For good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, FRANKLIN, on behalf of itself and its past, present or future partners, employees, directors, officers, attorneys, shareholders, representatives, receivers, insurers, agents, successors, and assigns (the "INSURED RELEASOR") hereby releases, discharges, and covenants not to sue Great Northern or any of its direct and indirect parents, subsidiaries, 1 affiliates, or related companies, and each and all of their respective parents, subsidiaries, affiliates, or related companies, and each and all of their respective past, present or future partners, employees, directors, officers, shareholders, attorneys, representatives, receivers, insurers, agents, successors, and assigns (the "INSURER RELEASEE"), from and with respect to any and all claims, demands, liens, agreements, contracts, covenants, actions, suits, causes of action, wages, obligations, debts, expenses, attorneys' fees, damages, judgments, orders, and liabilities of whatever kind or nature in law, equity, or otherwise, whether now known or unknown, suspected or unsuspected, and whether or not concealed or hidden, which INSURED RELEASOR acting by or through FRANKLIN now owns or holds or has at any time heretofore owned or held as against the INSURER RELEASEE, or any of them, with respect to the claims asserted by or that it could have asserted in connection with its 9-11 Claim under Policy No. 3533-87-15, effective from November 1, 2000 to November 1, 2001, issued by Great Northern to FRANKLIN. 4. COVENANT OF AUTHORITY BY FRANKLIN. FRANKLIN represents, covenants and warrants that it has full authority to enter into this Agreement, and that it has not assigned or otherwise transferred any claim released by virtue of this Agreement, and that no other person or entity has or has had any interest in the claims relating to the subject matter hereof, including but not limited to any loss payees named on the policy or entitled to be named on the policy. The undersigned further agrees to indemnify and hold harmless Great Northern if the foregoing warranties prove untrue. 5. COVENANT OF AUTHORITY BY GREAT NORTHERN. Great Northern represents, covenants and warrants that it has full authority to enter into this Agreement, and that it has not assigned or otherwise transferred any claim released by virtue of this Agreement. 6. CONFIDENTIALITY. The Parties shall use their best efforts to keep the negotiations and discussions that led to this Agreement confidential for all time, except as may be required by statute, rule, regulation, generally accepted accounting principles, court order, or as otherwise required by law. The Parties agree to take all appropriate steps to ensure the confidentiality of the Agreement itself. No Party shall voluntarily show or give the Agreement to any other person or entity, except that a Party may show or give the Agreement to its auditors, accountants, regulators, reinsurers, and attorneys, or as may be reasonably necessary to enforce this Agreement. In the event this Agreement is to be filed or lodged with a court in connection with any proceeding, the Party seeking to do so shall use reasonable efforts to preserve its confidentiality under seal of court at all times. The Parties shall inform any person to whom this Agreement is shown or given that it is confidential and require that it not be shown or given to any other person. In the event any Party to this Agreement receives a subpoena or other similar instrument that seeks to compel disclosure of any material or information covered by this section, that Party shall promptly inform all Parties to this Agreement of the receipt of the subpoena or other instrument, and shall, consistent with law, afford all Parties adequate time to exercise whatever rights those Parties may have to seek protection from disclosure of this Agreement. Nothing contained in this section or in the Agreement as a whole shall prohibit FRANKLIN from sharing the Agreement and/or discussing its negotiations with FRANKLIN partners and employees; provided such partners 2 and employees are are advised of and comply with the confidentiality obligations set out in this section. 7. NO ADMISSIONS. Neither this Agreement, nor anything contained in it, is an admission by any of the Parties hereto, nor shall this Agreement constitute an admission by or be used as an admission against any of the Parties, or any of their direct and indirect parents, subsidiaries, affiliates, or related companies, or, in the case of FRANKLIN, its partners or employees, or as evidence of any liability or wrongdoing whatsoever, including any violation of foreign, federal, state, local, or common laws, ordinances, or regulations. 8. EXECUTION; COPIES. This Agreement may be executed in counterparts, and each counterpart, when executed, shall have the effect of a signed original. This Agreement shall be deemed to have been executed when the parties hereto each execute and exchange counterparts thereof, which may be accomplished by facsimile or in person in accordance with the conveniences of the Parties hereto. This Agreement is not binding and shall be of no force and effect whatsoever unless and until this Agreement is executed by all parties hereto. Photographic and facsimile copies of such signed counterparts may be used in lieu of the originals for any purpose. 9. APPLICABLE LAW. This Agreement shall be construed and enforced in accordance with the laws of the State of New York, without regard to the conflicts of law principles thereof. In connection with any action, suit, or proceeding arising out of or relating to this Agreement, the Parties agree to submit to the exclusive jurisdiction and venue of the United States District Court for the Southern District of New York (provided that Court has subject matter jurisdiction). 10. INTEGRATED AGREEMENT. This Agreement represents the entire agreement of the Parties. The Parties acknowledge that no representation or promise not expressly set forth in this Agreement has been made by any of the Parties hereto or any of their agents, employees, representatives, or attorneys. No modification of, or amendment to, this Agreement shall be valid unless it is in writing and signed by the Parties. . 3 IN WITNESS WHEREOF, the Parties hereto, intending to be legally bound, have caused this Agreement to be executed as a sealed instrument as of the dates set forth below. GREAT NORTHERN INSURANCE COMPANY By: /s/ Chris Copeland ------------------ Print: Chris Copeland Date: 1-16-03 FRANKLIN RESOURCES, INC. By: /s/ Leslie M. Kratter --------------------- Print: LESLIE M. KRATTER Date: January 15, 2004 4 EX-12 3 exh12.txt
EXHIBIT 12 ---------- COMPUTATIONS OF RATIOS OF EARNINGS TO FIXED CHARGES THREE MONTHS ENDED SIX MONTHS ENDED MARCH 31, MARCH 31, (IN THOUSANDS) 2004 2003 2004 2003 -------------------------------------------------------------------------------------------------- Income before taxes on income and cumulative effect of an accounting change $252,176 $152,227 $488,116 $300,953 Add fixed charges: Interest expense - excluding interest on deposits 8,053 3,711 15,729 7,587 Interest expense - deposits 1,040 1,573 2,182 3,380 Interest factor on rent /1 3,047 3,942 6,418 6,557 -------------------------------------------------------------------------------------------------- Total fixed charges 12,140 9,226 24,329 17,524 -------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------- Earnings before fixed charges and taxes on $264,316 $161,453 $512,445 $318,477 income -------------------------------------------------------------------------------------------------- Ratio of earnings to fixed charges - including interest on deposits 21.8 17.5 21.1 18.2 Ratio of earnings to fixed charges - excluding interest on deposits 23.7 20.9 23.0 22.3 -------------------------------------------------------------------------------------------------- /1 Interest factor on rent represents one-third of rental expense (the approximate portion of rental expense representing interest).
EX-31 4 exh31_1.txt EXHIBIT 31.1 EXHIBIT 31.1 ------------ CERTIFICATION I, Martin L. Flanagan, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Franklin Resources, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c. Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: May 14, 2004 /S/ MARTIN L. FLANAGAN ------------------------------------- Martin L. Flanagan President and Co-Chief Executive Officer EX-31 5 exh31_2.txt EXHIBIT 31.2 EXHIBIT 31.2 ------------ CERTIFICATION I, Gregory E. Johnson, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Franklin Resources, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c. Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: May 14, 2004 /S/ GREGORY E. JOHNSON ------------------------------------- Gregory E. Johnson President and Co-Chief Executive Officer EX-31 6 exh31_3.txt EXHIBIT 31.3 EXHIBIT 31.3 ------------ CERTIFICATION I, James R. Baio, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Franklin Resources, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c. Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: May 14, 2004 /S/ JAMES R. BAIO ------------------------- James R. Baio Senior Vice President and Chief Financial Officer EX-32 7 exh32_1.txt EXHIBIT 32.2 EXHIBIT 32.1 ------------ CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 (FURNISHED HEREWITH) I, Martin L. Flanagan, President and Co-Chief Executive Officer of Franklin Resources, Inc. (the "Company"), certify, pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to my knowledge: 1. The quarterly report on Form 10-Q of the Company for the quarterly period ended March 31, 2004 (the "Report") fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: May 14, 2004 /S/ MARTIN L. FLANAGAN ------------------------------------- Martin L. Flanagan President and Co-Chief Executive Officer EX-32 8 exh32_2.txt EXHIBIT 32.2 EXHIBIT 32.2 ------------ CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 (FURNISHED HEREWITH) I, Gregory E. Johnson, President and Co-Chief Executive Officer of Franklin Resources, Inc. (the "Company"), certify, pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to my knowledge: 1. The quarterly report on Form 10-Q of the Company for the quarterly period ended March 31, 2004 (the "Report") fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: May 14, 2004 /S/ GREGORY E. JOHNSON ------------------------------------- Gregory E. Johnson President and Co-Chief Executive Officer EX-32 9 exh32_3.txt EXHIBIT 32.3 EXHIBIT 32.3 ------------ CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 (FURNISHED HEREWITH) I, James R. Baio, Senior Vice President and Chief Financial Officer of Franklin Resources, Inc. (the "Company"), certify, pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to my knowledge: 1. The quarterly report on Form 10-Q of the Company for the quarterly period ended March 31, 2004 (the "Report") fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: May 14, 2004 /S/ JAMES R. BAIO ------------------------- James R. Baio Senior Vice President and Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----