FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For Quarterly Period Ended December 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.)
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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.
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
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: 250,379,789 shares, common stock, par value $.10 per share, at January 31, 2005.
PART I - FINANCIAL INFORMATION
ITEM 1. CONDENSED FINANCIAL STATEMENTS.
FRANKLIN RESOURCES, INC.
CONSOLIDATED STATEMENTS OF INCOME
UNAUDITED THREE MONTHS ENDED
DECEMBER 31,
(in thousands, except per share data) 2004 2003
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OPERATING REVENUES
Investment management fees $566,483 $454,508
Underwriting and distribution fees 340,378 276,249
Shareholder servicing fees 63,167 61,338
Consolidated sponsored investment products income, net 615 26
Other, net 15,379 17,545
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Total operating revenues 986,022 809,666
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OPERATING EXPENSES
Underwriting and distribution 311,422 248,728
Compensation and benefits 211,507 189,204
Information systems, technology and occupancy 66,805 69,648
Advertising and promotion 26,108 21,232
Amortization of deferred sales commissions 31,378 22,448
Amortization of intangible assets 4,411 4,402
Other 34,307 31,144
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Total operating expenses 685,938 586,806
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Operating income 300,084 222,860
OTHER INCOME (EXPENSES)
Consolidated sponsored investment products gains, net 16,163 4,000
Investment and other income, net 27,389 16,191
Interest expense (7,987) (7,111)
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Other income, net 35,565 13,080
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Income before taxes on income and cumulative effect of an accounting change 335,649 235,940
Taxes on income 95,660 68,423
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Income before cumulative effect of an accounting change, net of tax 239,989 167,517
Cumulative effect of an accounting change, net of tax -- 4,779
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NET INCOME $239,989 $172,296
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BASIC EARNINGS PER SHARE
Income before cumulative effect of an accounting change $0.96 $0.68
Cumulative effect of an accounting change -- 0.02
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NET INCOME $0.96 $0.70
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DILUTED EARNINGS PER SHARE
Income before cumulative effect of an accounting change $0.92 $0.65
Cumulative effect of an accounting change -- 0.02
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NET INCOME $0.92 $0.67
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DIVIDENDS PER SHARE $0.100 $0.085
See accompanying notes to the consolidated financial statements.
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FRANKLIN RESOURCES, INC.
CONSOLIDATED BALANCE SHEETS
UNAUDITED
DECEMBER 31, SEPTEMBER 30,
(in thousands) 2004 2004
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ASSETS
CURRENT ASSETS
Cash and cash equivalents $2,912,529 $2,814,184
Receivables 432,995 406,247
Investment securities, trading 236,457 257,329
Investment securities, available-for-sale 519,767 432,665
Deferred taxes and other 143,906 133,787
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Total current assets 4,245,654 4,044,212
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BANKING/FINANCE ASSETS
Cash and cash equivalents 192,681 103,004
Loans held for sale, net 40,702 82,481
Loans receivable, net 314,258 334,676
Investment securities, available-for-sale 234,475 265,870
Other 45,871 39,813
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Total banking/finance assets 827,987 825,844
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NON-CURRENT ASSETS
Investments, other 428,869 388,819
Deferred sales commissions 314,641 299,069
Property and equipment, net 463,894 470,578
Goodwill 1,388,830 1,381,757
Other intangible assets, net 669,120 671,500
Receivable from banking/finance group 6,253 37,784
Other 106,000 108,572
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Total non-current assets 3,377,607 3,358,079
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TOTAL ASSETS $8,451,248 $8,228,135
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See accompanying notes to the consolidated financial statements.
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FRANKLIN RESOURCES, INC.
CONSOLIDATED BALANCE SHEETS
UNAUDITED
DECEMBER 31, SEPTEMBER 30,
(in thousands, except share data) 2004 2004
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LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Compensation and benefits $179,024 $284,483
Commercial paper 170,000 170,000
Accounts payable and accrued expenses 195,818 249,789
Commissions 148,838 128,341
Income taxes 111,996 76,862
Other 19,591 11,640
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Total current liabilities 825,267 921,115
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BANKING/FINANCE LIABILITIES
Deposits 637,750 555,746
Payable to parent 6,253 37,784
Other 58,250 65,187
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Total banking/finance liabilities 702,253 658,717
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NON-CURRENT LIABILITIES
Long-term debt 1,215,774 1,196,409
Deferred taxes 240,904 236,126
Other 35,148 32,895
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Total non-current liabilities 1,491,826 1,465,430
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Total liabilities 3,019,346 3,045,262
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MINORITY INTEREST 92,570 76,089
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;
250,242,679 and 249,680,498 shares issued and outstanding, for
December 31, 2004 and September 30, 2004 25,024 24,968
Capital in excess of par value 256,783 255,137
Retained earnings 4,966,489 4,751,504
Deferred compensation (29,717) --
Accumulated other comprehensive income 120,753 75,175
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Total stockholders' equity 5,339,332 5,106,784
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TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $8,451,248 $8,228,135
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See accompanying notes to the consolidated financial statements.
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FRANKLIN RESOURCES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
UNAUDITED
THREE MONTHS ENDED
DECEMBER 31,
(in thousands) 2004 2003
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NET INCOME $239,989 $172,296
Adjustments to reconcile net income to net cash
provided by operating activities:
Increase in receivables, prepaid expenses and other (18,439) (7,978)
Advances of deferred sales commissions (46,949) (52,886)
Decrease in other current liabilities (26,801) (2,863)
Provision for governmental investigations, proceedings and actions (3,257) --
Increase in deferred income taxes and taxes payable 29,667 35,036
Increase in commissions payable 20,498 13,551
Decrease in accrued compensation and benefits (57,732) (29,302)
Originations of loans held for sale, net (135,470) (69,926)
Net proceeds from securitization of loans held for sale 177,249 --
Net change in trading securities 23,169 (3,201)
Equity in net income of affiliated companies (8,330) (1,884)
Depreciation and amortization 48,704 45,014
Net gains on disposal of assets (2,407) (3,123)
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Net cash provided by operating activities 239,891 94,734
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Purchase of investments (267,934) (1,211,047)
Liquidation of investments 168,598 1,218,959
Purchase of banking/finance investments (282) (614)
Liquidation of banking/finance investments 30,174 19,657
Net proceeds from securitization of loans receivable -- 179,965
Net origination of loans receivable 21,165 (25,006)
Net additions of property and equipment (4,795) (7,747)
Acquisition of subsidiaries, net of cash acquired -- (40,766)
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Net cash (used in) provided by investing activities (53,074) 133,401
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Increase (decrease) in bank deposits 82,004 (210)
Exercise of common stock options 41,130 78,035
Dividends paid on common stock (21,200) (18,485)
Purchase of common stock (117,728) (12,524)
Increase in debt 26,179 30,637
Payments on debt (9,180) (6,507)
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Net cash provided by financing activities 1,205 70,946
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Increase in cash and cash equivalents 188,022 299,081
Cash and cash equivalents, beginning of period 2,917,188 1,053,695
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CASH AND CASH EQUIVALENTS, END OF PERIOD $3,105,210 $1,352,776
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[Table continued on next page]
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[Table continued on next page]
FRANKLIN RESOURCES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
UNAUDITED
THREE MONTHS ENDED
DECEMBER 31,
(in thousands) 2004 2003
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SUPPLEMENTAL DISCLOSURE OF NON-CASH INFORMATION
Value of common stock issued, principally restricted stock $77,444 $42,562
Total assets related to the consolidation of certain sponsored
investment products and a lessor trust, net of deconsolidated assets (6,953) 212,008
Total liabilities related to the consolidation of certain sponsored
investment products and a lessor trust, net of deconsolidated liabilities (1,738) 215,197
Fair value of subsidiary assets acquired -- 40,899
Fair value of subsidiary liabilities assumed -- 5,778
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See accompanying notes to the consolidated financial statements.
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FRANKLIN RESOURCES, INC.
Notes to Consolidated Financial Statements December 31, 2004
(Unaudited)
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, 2004. Certain amounts for the comparative prior year periods have been reclassified to conform to the financial presentation for and at the period ended December 31, 2004.
In December 2004, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 123 (revised 2004), "Share-Based Payment" ("SFAS 123R"). SFAS 123R addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for equity instruments of the enterprise. It also addresses transactions in which an entity incurs liabilities in exchange for goods and services that are based on the fair value of the enterprise's equity instruments or that may be settled by the issuance of such equity instruments. SFAS 123R requires an entity to recognize the grant-date fair-value of stock options and other equity-based compensation issued to employees in the income statement. The revised statement generally requires that an entity account for those transactions using the fair-value-based method, and eliminates the intrinsic value method of accounting in APB Opinion No. 25, "Accounting for Stock Issued to Employees". SFAS 123R also requires entities to disclose information about the nature of the share-based payment transactions, the method used to estimate fair value of goods and services received or the value of the equity instruments granted, and the effects of those transactions on the financial statements. For public entities that do not file as small business issuers, the revised pronouncement is effective as of the beginning of the first interim or annual reporting period that begins after June 15, 2005 and applies to all awards granted after the required effective date and to awards modified, repurchased, or cancelled after that date. For entities that currently apply the fair-value-based method for either recognition or disclosure under the original pronouncement, Statement of Financial Accounting Standards No. 123 "Accounting for Stock-Based Compensation", the revised statement also applies to the portion of outstanding awards for which the requisite service has not yet been rendered based on the grant-date value of these awards. Retrospective application is permitted. We have not completed our evaluation of the impact of adoption of SFAS 123R on our financial position and results of operation.
In October 2004, the Emerging Issues Task Force Issue No. 04-8, "The Effect of Contingently Convertible Debt on Diluted Earnings per Share" ("EITF 04-8"), was ratified. EITF 04-8 was effective for reporting periods ending after December 15, 2004 and required the restatement of diluted earnings per share for comparative prior year periods. EITF 04-8 required us to include the potential conversion into common stock of our zero coupon convertible senior notes (see Note 11) in the calculation of diluted earnings per share, even if the conditions that must be satisfied to allow conversion have not been met. Its adoption resulted in a decrease in diluted earnings per share of $0.02 for the quarters ended December 31, 2004 and 2003 (See Note 5).
In December 2004, the FASB issued Staff Position No. 109-2, "Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004" ("FSP FAS 109-2"). The American Jobs Creation Act of 2004 (the "Act") was signed into law on October 22, 2004. Under a provision of the Act, we may elect to repatriate certain earnings of our foreign-based subsidiaries at a reduced federal tax rate in either of our fiscal years endings September 30, 2005 or September 30, 2006. FSP FAS 109-2 provides guidance on when an enterprise should recognize in its financial statements the effects of the one-time tax benefit of repatriation of foreign earnings under the Act, and specifies interim
disclosure requirements. We are currently evaluating the effect of this repatriation provision; however, we do not expect to complete this evaluation until after the U.S. Congress or the U.S. Department of the Treasury issue additional guidance regarding this provision. The range of possible amounts we are considering for repatriation is between zero and $1.9 billion, and the potential range of income tax associated with amounts subject to the reduced rate is between zero and $117.0 million.
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 ($31.3 million), definite-lived management contracts ($3.4 million) and goodwill ($41.2 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, as of the date of purchase. 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.
The following table computes comprehensive income.
THREE MONTHS ENDED
DECEMBER 31,
(in thousands) 2004 2003
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Net income $239,989 $172,296
Net unrealized gains on investments, net of tax 18,680 17,777
Currency translation adjustments 26,898 12,789
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COMPREHENSIVE INCOME $285,567 $202,862
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We computed earnings per share as follows:
THREE MONTHS ENDED
DECEMBER 31,
(in thousands, except per share data) 2004 2003
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Net income $239,989 $172,296
Adjusted net income in accordance with EITF 04-8 242,183 174,443
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Weighted-average shares outstanding - basic 250,418 247,758
Incremental shares from assumed conversions:
Common stock options 4,002 2,476
Zero coupon convertible senior notes 8,209 8,209
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Weighted-average shares outstanding - diluted 262,629 258,443
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BASIC EARNINGS PER SHARE
Income before cumulative effect of an accounting change $0.96 $0.68
Cumulative effect of an accounting change -- 0.02
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Net income $0.96 $0.70
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DILUTED EARNINGS PER SHARE
Income before cumulative effect of an accounting change $0.92 $0.65
Cumulative effect of an accounting change -- 0.02
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Net income $0.92 $0.67
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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, provided the employee, among other conditions, holds the purchased shares 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 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
DECEMBER 31,
(in thousands, except per share data) 2004 2003
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Net income, as reported $239,989 $172,296
Less: stock-based compensation expense determined under the fair
value method, net of tax (8,391) (10,806)
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PRO FORMA NET INCOME $231,598 $161,490
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BASIC EARNINGS PER SHARE
As reported $0.96 $0.70
Pro forma 0.92 0.65
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Adjusted net income in accordance with EITF 04-8, as reported $242,183 $174,443
Less: stock-based compensation expense determined under the fair
value method, net of tax (8,391) (10,806)
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PRO FORMA NET INCOME $233,792 $163,637
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DILUTED EARNINGS PER SHARE
As reported $0.92 $0.67
Pro forma 0.89 0.63
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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 DECEMBER 31, 2004
-------------------------------------------
SPONSORED
BEFORE INVESTMENT
(in thousands) CONSOLIDATION PRODUCTS CONSOLIDATED
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OPERATING REVENUES
Investment management fees $567,281 $(798) $566,483
Underwriting and distribution fees 340,449 (71) 340,378
Shareholder servicing fees 63,175 (8) 63,167
Consolidated sponsored investment products income, net 0 615 615
Other, net 15,379 -- 15,379
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Total operating revenues 986,284 (262) 986,022
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OPERATING EXPENSES 685,938 0 685,938
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Operating income 300,346 (262) 300,084
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OTHER INCOME (EXPENSES)
Consolidated sponsored investment product gains, net -- 16,163 16,163
Investment and other income, net 32,263 (4,874) 27,389
Interest expense (7,984) (3) (7,987)
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Other income, net 24,279 11,286 35,565
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Income before taxes on income 324,625 11,024 335,649
Taxes on income 92,518 3,142 95,660
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NET INCOME $232,107 $7,882 $239,989
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AS OF DECEMBER 31, 2004
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SPONSORED
BEFORE INVESTMENT
(in thousands) CONSOLIDATION PRODUCTS CONSOLIDATED
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ASSETS
Current assets $4,125,890 $119,764 $4,245,654
Banking/finance assets 827,987 -- 827,987
Non-current assets 3,407,649 (30,042) 3,377,607
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TOTAL ASSETS $8,361,526 $89,722 $8,451,248
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LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities $817,020 $8,247 $825,267
Banking/finance liabilities 702,253 -- 702,253
Non-current liabilities 1,486,828 4,998 1,491,826
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TOTAL LIABILITIES 3,006,101 13,245 3,019,346
Minority interest 17,909 74,661 92,570
Total stockholders' equity 5,337,516 1,816 5,339,332
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TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $8,361,526 $89,722 $8,451,248
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Cash and cash equivalents consist of the following:
DECEMBER 31, SEPTEMBER 30,
(in thousands) 2004 2004
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Cash and due from banks $362,648 $341,891
Federal funds sold and securities purchased under agreements to resell 135,053 64,029
Money market funds, time deposits and other 2,607,509 2,511,268
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TOTAL $3,105,210 $2,917,188
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Federal Reserve Board regulations require reserve balances on deposits to be maintained with the Federal Reserve Banks by banking subsidiaries. Required reserve balances totaled $1.9 million at December 31, 2004 and at September 30, 2004.
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
DECEMBER 31,
(in thousands) 2004 2003
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Gross sale proceeds $178,773 $185,071
Less: net carrying amount of loans sold 178,105 180,838
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PRE-TAX GAIN $668 $4,233
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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
DECEMBER 31,
2004 2003
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Excess cash flow discount rate (annual rate) 12.0% 12.0%
Cumulative life loss rate 3.7% 3.4%
Pre-payment speed assumption (average monthly rate) 1.5% 1.8%
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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.
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:
DECEMBER 31, SEPTEMBER 30,
(in thousands) 2004 2004
---------------------------------------------------------------- --------------- ---------------
CARRYING AMOUNT/FAIR VALUE OF INTEREST-ONLY STRIPS $31,555 $31,808
EXCESS CASH FLOW DISCOUNT RATE (ANNUAL RATE) 12.0% 12.0%
Impact on fair value of 10% adverse change $(457) $(240)
Impact on fair value of 20% adverse change (900) (476)
CUMULATIVE LIFE LOSS RATE 3.7% 3.9%
Impact on fair value of 10% adverse change $(2,417) $(2,677)
Impact on fair value of 20% adverse change (4,837) (5,354)
PRE-PAYMENT SPEED ASSUMPTION (AVERAGE MONTHLY RATE) 1.8% 1.8%
Impact on fair value of 10% adverse change $(3,282) $(3,479)
Impact on fair value of 20% adverse change (6,540) (6,894)
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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
DECEMBER 31,
(in thousands) 2004 2003
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Servicing fees received $3,291 $3,089
Other cash flows received 5,900 5,465
Purchase of loans from trusts (12,113) (378)
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Amounts payable to the trustee related to loan principal and interest collected on behalf of the trusts of $39.7 million at December 31, 2004, and $40.6 million at September 30, 2004, are included in other banking/finance liabilities.
The securitized loan portfolio that we manage and the related delinquencies were as follows:
DECEMBER 31, SEPTEMBER 30,
(in thousands) 2004 2004
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Securitized loans held by securitization trusts $844,824 $768,936
Delinquencies 15,628 13,301
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Net charge-offs on the securitized loan portfolio were $3.5 million and $5.1 million for the three months ended December 31, 2004 and 2003.
Goodwill and indefinite-lived intangible assets, including those acquired before initial application of Statements of Financial Accounting Standards No. 141, "Business Combinations" and No. 142, "Goodwill and Other Intangible Assets", are not amortized but are tested for impairment at least annually.
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.
We completed our latest annual impairment testing of goodwill and indefinite-lived and definite-lived intangible assets during the quarter ended March 31, 2004, and we determined that there was no impairment in the value of these assets as of October 1, 2003.
Intangible assets, other than goodwill were as follows:
GROSS NET
CARRYING ACCUMULATED CARRYING
(in thousands) AMOUNT AMORTIZATION AMOUNT
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BALANCE, DECEMBER 31, 2004
Amortized intangible assets:
Customer base $233,526 $(58,719) $174,807
Other 34,933 (22,248) 12,685
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268,459 (80,967) 187,492
Non-amortized intangible assets
Management contracts 481,628 -- 481,628
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TOTAL $750,087 $(80,967) $669,120
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BALANCE, SEPTEMBER 30, 2004
Amortized intangible assets
Customer base $233,205 $(54,716) $178,489
Other 34,933 (21,730) 13,203
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268,138 (76,446) 191,692
Non-amortized intangible assets
Management contracts 479,808 -- 479,808
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TOTAL $747,946 $(76,446) $671,500
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Estimated amortization expense for each of the next 5 fiscal years is as follows:
FOR THE FISCAL YEARS ENDING
(in thousands) SEPTEMBER 30,
------------------------------------------------------------------ -----------------------------
2005 $17,039
2006 17,039
2007 17,039
2008 17,039
2009 17,039
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The change in the carrying value of goodwill was as follows:
(in thousands) ------------------------------------------------------------------------------------------------ Goodwill as of September 30, 2004 $1,381,757 Foreign currency movements 7,073 ------------------------------------------------------------------------------------------------ GOODWILL AS OF DECEMBER 31, 2004 $1,388,830 ------------------------------------------------------------------------------------------------ |
Outstanding debt consisted of the following:
DECEMBER 31, SEPTEMBER 30,
(in thousands) 2004 2004
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CURRENT
Federal funds purchased $250 $--
Federal Home Loan Bank advances -- 6,000
Commercial paper 170,000 170,000
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170,250 176,000
NON-CURRENT
Convertible Notes (including accrued interest) 532,599 530,120
Medium Term Notes 420,000 420,000
Other 263,175 246,289
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1,215,774 1,196,409
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TOTAL DEBT $1,386,024 $1,372,409
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Federal funds purchased are included in deposits and 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. In September 2004, we purchased the headquarters campus from the lessor trust that held these assets, and we issued $170.0 million of commercial paper to finance the transaction.
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. To date, we have 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. We may redeem the remaining Convertible Notes for cash on or after May 11, 2006 or 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 pay the accreted value of the Convertible Notes in cash or shares of our common stock. The amount that the holders may redeem in the future will depend 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 December 31, 2004 and September 30, 2004.
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 of the Retirement Plan termination with the Internal Revenue Service. As of December 31, 2004, the Internal Revenue Service has not approved the Retirement Plan termination, and therefore, 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
DECEMBER 31, DECEMBER 31,
(in thousands) 2004 2003 2004 2003
------------------------------------------------------------------------------------------------
Service cost $-- $242 $12 $7
Interest cost 392 323 101 80
Expected return on plan assets (226) (193) -- --
Amortization of prior service costs -- (32) 64 --
Amortization of net loss 1,420 950 13 --
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NET PERIODIC BENEFIT COST $1,586 $1,290 $190 $87
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In the three months ended December 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 $14.4 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. The benefit liability for this anticipated funding has been accrued in our financial statements as of September 30, 2004.
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 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 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 December 31, 2004, the maximum potential amount of future payments related to these obligations was $29.5 million. In addition, our Consolidated Balance Sheet at December 31, 2004 included a $0.5 million liability to reflect the fair value of certain additional obligations arising from auto securitization transactions.
At December 31, 2004, our banking/finance operating segment had issued financial standby letters of credit totaling $2.6 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 $2.2 million as of December 31, 2004 and commercial real estate.
GOVERNMENTAL INVESTIGATIONS, PROCEEDINGS AND ACTIONS
INVESTIGATIONS. As part of various investigations by a number of federal, state, and foreign regulators and governmental entities, including the Securities and Exchange Commission ("SEC"), the California Attorney General's Office ("CAGO"), and the National Association of Securities Dealers, Inc. ("NASD"), relating to certain practices in the mutual fund industry, including late trading, market timing and marketing support payments to securities dealers who sell fund shares, Franklin Resources, Inc. and certain of its subsidiaries (as used in this section, together, the "Company"), as well as certain current or former executives and employees of the Company, received subpoenas and/or requests for documents, information and/or testimony. The Company and its current employees provided documents and information in response to those requests and subpoenas.
Franklin Templeton Investments Corp. ("FTIC"), a Company subsidiary and the investment manager of Franklin Templeton's Canadian mutual funds, has been cooperating with and responding to requests for information from the Ontario Securities Commission (the "OSC") relating to the OSC's review of frequent trading practices within the Canadian mutual fund industry. On December 10, 2004, FTIC received a letter indicating that the staff of the OSC is contemplating enforcement proceedings against FTIC before the OSC. In its letter, the OSC staff expressed the view that, over the period of February 1999 to February 2003, there were certain accounts that engaged in a frequent trading market timing strategy in certain funds being managed by FTIC. The letter also gave FTIC the opportunity to respond to the issues raised in the letter and to provide the OSC staff with additional information relevant to those matters. The Company has entered into discussions with the OSC staff in an effort to resolve the issues raised in the OSC's review. The Company cannot predict the likelihood of whether those discussions will result in a settlement or the terms or amount of any such settlement. Should a settlement be reached, the amount could be material to the Company's financial results.
On December 9, 2004, the enforcement staff of the NASD informed the Company that it had made a preliminary determination to recommend a disciplinary proceeding against Franklin/Templeton Distributors, Inc. ("FTDI"), alleging that FTDI violated certain NASD rules by the use of directed brokerage commissions to pay for sales and marketing support. The enforcement staff has since advised the Company that it has determined not to recommend a disciplinary proceeding against FTDI and has concluded its investigation of this matter. Separately, FTDI has also received a letter from the NASD staff advising of its preliminary determination to recommend a disciplinary proceeding against FTDI alleging violation of certain NASD rules relating to FTDI's Top Producers program. The Company believes that any such charges are unwarranted and has responded with a submission as to why such action is not warranted. As of the date of this filing, the NASD staff has not taken any further action.
SETTLEMENTS. Beginning in August 2004, the Company entered into settlements with certain regulators investigating the mutual fund industry practices noted above. The Company believes that settlement of each of the matters described in this section is in the best interest of the Company and shareholders of the Franklin Templeton mutual funds (the "Funds").
On August 2, 2004, Franklin Resources, Inc. announced that its subsidiary, Franklin Advisers, Inc. ("Franklin Advisers") reached an agreement with the SEC that resolved the issues resulting from the previously disclosed SEC investigation into market timing activity. In connection with that agreement, the SEC issued an "Order Instituting Administrative and Cease-and-Desist Proceedings Pursuant to Sections 203(e) and 203(k) of the Investment Advisers Act of 1940 and Sections 9(b) and 9(f) of the Investment Company Act of 1940, Making Findings and Imposing Remedial Sanctions and a Cease-and-Desist Order" (the "Order"). The SEC's Order concerned the activities of a limited number of third parties that ended in 2000 and those that were the subject of the first Massachusetts administrative complaint described below.
Under the terms of the SEC's Order, pursuant to which Franklin Advisers neither admitted nor denied any of the findings contained therein, Franklin Advisers agreed to pay $50 million to be distributed to shareholders of certain of the Funds, of which $20 million was a civil penalty. The settlement and related legal and distribution costs of $60 million ($45.6 million, net of taxes) were recorded as a charge to income in the fiscal quarter ended March 31, 2004.
The Order required Franklin Advisers to, among other things:
* Enhance and periodically review compliance policies and procedures,
and establish a corporate ombudsman;
* Establish a new internal position whose responsibilities shall include
compliance matters related to conflicts of interests; and
* Retain an Independent Distribution Consultant to develop a plan to
distribute the $50 million settlement to Fund shareholders.
The Order further provided that in any related investor actions, Franklin Advisers would not benefit from any offset or reduction of any investor's claim by the amount of any distribution from the above-described $50 million to such investor that is proportionately attributable to the civil penalty paid by Franklin Advisers.
On September 20, 2004, Franklin Resources, Inc. announced that two of its subsidiaries, Franklin Advisers and Franklin Templeton Alternative Strategies, Inc. ("FTAS"), reached an agreement with the Securities Division of the Office of the Secretary of the Commonwealth of Massachusetts (the "State of Massachusetts") related to its administrative complaint filed on February 4, 2004, concerning one instance of market timing that was also a subject of the August 2, 2004 settlement that Franklin Advisers reached with the SEC, as described above. Under the terms of the settlement consent order issued by the State of Massachusetts, Franklin Advisers and FTAS consented to the entry of a cease-and-desist order and agreed to pay a $5 million administrative fine to the State of Massachusetts (the "Massachusetts Consent Order"). The Company recorded this expense in the quarter ended September 30, 2004. The Massachusetts Consent Order included two different sections: "Statements of Fact" and "Violations of Massachusetts Securities Laws." Franklin Advisers and FTAS admitted the facts in the Statements of Fact.
On October 25, 2004, the State of Massachusetts filed a second administrative complaint, alleging that Franklin Resources, Inc.'s Form 8-K filing (in which it described the Massachusetts Consent Order and stated that "Franklin did not admit or deny engaging in any wrongdoing") failed to state that Franklin Advisers and FTAS admitted the Statements of Fact portion of the Massachusetts Consent Order (the "Second Complaint"). Franklin Resources, Inc. reached a second agreement with the State of Massachusetts on November 19, 2004, resolving the Second Complaint. As a result of the November 19, 2004 settlement, Franklin Resources, Inc. filed a new Form 8-K. The terms of the Massachusetts Consent Order did not change and there was no monetary fine associated with this second settlement.
On November 17, 2004, Franklin Resources, Inc. announced that FTDI reached an agreement with the CAGO, resolving the issues resulting from the CAGO's investigation concerning sales and marketing support payments. Under the terms of the settlement, FTDI neither admitted nor denied the allegations in the CAGO's complaint and agreed to pay $2 million to the State of California as a civil penalty, $14 million to the Funds, to be allocated by an independent distribution consultant to be paid for by FTDI, and $2 million to the CAGO for its investigative costs. The Company's results for the quarter and fiscal year ended September 30, 2004 included a charge to income of $18.5 million ($12.2 million, net of tax) related to this settlement.
On December 13, 2004, Franklin Resources, Inc. announced that its subsidiaries FTDI and Franklin Advisers reached an agreement with the SEC, resolving the issues resulting from the SEC's investigation concerning marketing support payments to securities dealers who sell Fund shares. In connection with that agreement, the SEC issued an "Order Instituting Administrative and Cease-and-Desist Proceedings, Making Findings, and Imposing Remedial Sanctions Pursuant to Sections 203(e) and 203(k) of the Investment Advisers Act of 1940, Sections 9(b) and 9(f) of the Investment Company Act of 1940, and Section 15(b) of the Securities Exchange Act of 1934" (the "Second Order").
Under the terms of the Second Order, in which FTDI and Franklin Advisers neither admitted nor denied the findings contained therein, they agreed to pay the Funds a penalty of $20 million and disgorgement of $1 (one dollar). FTDI and Franklin Advisers also agreed to implement certain measures and undertakings relating to marketing support payments to broker-dealers for the promotion or sale of Fund shares, including making additional disclosures in the Funds' Prospectuses and Statements of Additional Information. The Second Order further requires the appointment of an independent distribution consultant, at the Company's expense, who shall develop a plan for the distribution of the penalty and disgorgement to
the Funds. The Company recorded a charge of $21.5 million ($17.3 million, net of taxes) in its fiscal quarter ended June 30, 2004 related to this matter.
INTERNAL INQUIRIES. The Company also conducted its own internal fact-finding inquiry with the assistance of outside counsel to determine whether any Fund shareholders, 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 complete. We did not find any late trading, though we identified various instances of frequent trading. One officer of a subsidiary of Franklin Resources, Inc. was placed on administrative leave and subsequently resigned from his position with the Company in December 2003.
The Company found no instances of inappropriate mutual fund trading by any portfolio manager, investment analyst or officer of Franklin Resources, Inc. As previously disclosed, the Company 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. 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 reinstated the trader. The independent counsel concluded that some instances of the former Fund officer's trading violated Company policy, and the Company was prepared to institute appropriate disciplinary action. Subsequently, the former Fund officer resigned from his employment with 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 Funds, current and former officers, employees, and directors have been named in multiple lawsuits in different federal courts in Nevada, California, Illinois, New York, and Florida, alleging violations of various federal securities laws and seeking, among other relief, monetary damages, restitution, removal of Fund trustees, directors, advisers, administrators, and distributors, rescission of management contracts and 12b-1 Plans, and/or attorneys' fees 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 Franklin Resources, Inc. subsidiaries, resulting in alleged market timing activity. The majority of these lawsuits duplicate, in whole or in part, the allegations asserted in the February 4, 2004 Massachusetts administrative complaint and the findings in the SEC's August 2, 2004 Order, as described above. The lawsuits are styled as class actions, or derivative actions on behalf of either the named Funds or Franklin Resources, Inc.
To date, more than 240 similar lawsuits against at least 19 different mutual fund companies have been filed in federal district courts 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 in the United States District Court for the District of Maryland, entitled "In re Mutual Funds Investment Litigation" (the "MDL"). The Judicial Panel then transferred similar cases from different districts to the MDL for coordinated or consolidated pretrial proceedings.
As of February 8, 2005, the following federal lawsuits are pending against the Company (and in some instances, against certain officers, directors and/or Funds) and have been 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; 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; 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; 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; D'Alliessi 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; 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.
Plaintiffs in the MDL filed consolidated amended complaints on September 29, 2004. It is anticipated that defendants will file motions to dismiss in the coming months, with a hearing scheduled for June 2005.
As previously reported, various subsidiaries of Franklin Resources, Inc., as well as certain Templeton Fund registrants, have also been named in multiple class action 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 seeking, among other relief, monetary damages and attorneys' fees and costs, 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 of 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 state court actions and are not subject to the MDL.
In addition, FTIC has been named in two class action market timing lawsuits in Canada, seeking, among other relief, monetary damages, an order barring any increase in management fees for a period of two years following judgment, and/or attorneys' fees and costs, as follows: Huneault v. AGF Funds, Inc., et al., Case No. 500-06-000256-046, filed on October 25, 2004 in the Superior Court for the Province of Quebec, District of Montreal, and Heinrichs, et al. v. CI Mutual Funds, Inc., et al., Case No. 04-CV-29700, filed on December 17, 2004 in the Ontario Superior Court of Justice.
As previously reported, the Company, 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/or payment of allegedly excessive advisory, commission, and distribution fees, and seeking, among other relief, monetary damages, restitution, rescission of advisory contracts, including recovery of all fees paid pursuant to those contracts, an accounting of all monies paid to the named advisers, declaratory relief, injunctive relief, and/or attorneys' fees and costs. These lawsuits are styled as class actions or 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 and transferred to the United States District Court for the District of New Jersey on August 5, 2004 (plaintiffs voluntarily dismissed this action, without prejudice, on October 22,
2004); Wilcox v. Franklin Resources, Inc., et al., Case No. 04-2258 WHW, filed on May 12, 2004 in the United States District Court for the District of New Jersey; Bahe, Custodian CGM Roth Conversion IRA v. Franklin/Templeton Distributors, Inc., et al., Case No. 04-11195 PBS, filed on June 3, 2004 in the United States District Court for the District of Massachusetts.
The United States District Court for the District of New Jersey consolidated for pretrial purposes three of the above lawsuits (Stephen Alexander IRA, Tricarico, and Wilcox) into a single action, entitled "In re Franklin Mutual Funds Fee Litigation." Plaintiffs in those three lawsuits filed a consolidated amended complaint (the "Complaint") on October 4, 2004. Defendants filed a motion to dismiss the Complaint on November 19, 2004. It is anticipated that the matter will be heard in the coming months.
Management strongly believes that the claims made in each of the lawsuits identified above are without merit and intends to vigorously defend against them. The Company cannot predict with certainty, however, the eventual outcome of the remaining governmental investigations or private 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, it is 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 its 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.
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 established in Ireland to provide deferred commission assets financing. As of December 31, 2004, total assets of sponsored investment products in which we held a significant interest were approximately $2,100.2 million and our exposure to loss as a result of our interest in these products was $277.6 million. LFL had approximately $541.0 million in total assets at December 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 $55.7 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 December 31, 2004, we estimate that the termination fee payable in July 2006, not including costs associated with assuming equipment leases, would approximate $14.1 million and would decrease each month for the subsequent two years, reaching a payment of approximately $2.2 million in July 2008.
At December 31, 2004, our banking/finance operating segment had commitments to extend credit aggregating $241.2 million, primarily under credit card lines.
We lease office space and equipment under long-term operating leases. As of December 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 year ended September 30, 2004.
During the three months ended December 31, 2004, we purchased and retired 1.8 million shares at a cost of $117.7 million. At December 31, 2004, approximately 11.5 million shares remained available for
repurchase under board authorizations. During the three months ended December 31, 2003, we purchased and retired 0.3 million shares at a cost of $12.5 million.
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, Fiduciary Trust and Darby Overseas sponsored investment products. The banking/finance segment offers selected retail-banking services to high net-worth 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.
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 the provision for probable loan losses.
THREE MONTHS ENDED
DECEMBER 31,
(in thousands) 2004 2003
------------------------------------------------------------------------------------------------
OPERATING REVENUES
Investment management $973,609 $794,748
Banking/finance 12,413 14,918
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TOTAL $986,022 $809,666
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INCOME BEFORE TAXES AND CUMULATIVE EFFECT OF AN ACCOUNTING CHANGE
Investment management $329,777 $228,061
Banking/finance 5,872 7,879
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TOTAL $335,649 $235,940
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Operating segment assets were as follows:
DECEMBER 31, SEPTEMBER 30,
(in thousands) 2004 2004
------------------------------------------------------------------------------------------------
Investment management $7,623,261 $7,402,291
Banking/finance 827,987 825,844
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TOTAL $8,451,248 $8,228,135
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Operating revenues of the banking/finance segment included above were as follows:
THREE MONTHS ENDED
DECEMBER 31,
(in thousands) 2004 2003
------------------------------------------------------------------------------------------------
Interest on loans $6,242 $7,270
Interest and dividends on investment securities 2,130 2,964
------------------------------------------------------------------------------------------------
Total interest income 8,372 10,234
Interest on deposits (1,439) (1,193)
Interest on short-term debt (21) (61)
Interest expense - inter-segment (380) (489)
------------------------------------------------------------------------------------------------
Total interest expense (1,840) (1,743)
Net interest income 6,532 8,491
Other income 6,150 10,469
Provision for probable loan losses (269) (4,042)
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TOTAL OPERATING REVENUES $12,413 $14,918
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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 Statements of Income.
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 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, at December 31, 2004, and 2003, we exceeded the capital adequacy requirements applicable to us as listed below.
DECEMBER 31, SEPTEMBER 30, OUR CAPITAL
(in thousands) 2004 2004 ADEQUACY MINIMUM
---------------------------------------- ---------------- ----------------- --------------------
Tier 1 capital $3,358,587 $3,144,919 N/A
Total risk-based capital 3,361,538 3,148,617 N/A
Tier 1 leverage ratio 51% 50% 4%
Tier 1 risk-based capital ratio 82% 76% 4%
Total risk-based capital ratio 82% 76% 8%
---------------------------------------- ---------------- ----------------- --------------------
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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 the 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.
OVERVIEW
The past year was challenging for the mutual fund industry as various regulatory bodies continued their investigations of certain industry practices. While these investigations continue during the first quarter of fiscal 2005, current regulatory and legislative developments could adversely impact the mutual fund industry, our assets under management and profitability.
Despite these uncertainties, many of our key performance measures including net income, earnings per share and operating margin continued to improve during the first quarter of fiscal 2005. In part, we can attribute these improvements to our continued focus to broaden our client base geographically. This expansion, along with the overall increases in the global equity markets, has lead to increases in our assets under management driven from both market appreciation and positive cash flows into our sponsored investment products.
GENERAL
We derive the majority of our operating revenues, operating expenses and net income from providing investment advisory and related services to retail mutual funds, institutional accounts, high net-worth clients, private accounts and other investment products. This is our primary 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 six distinct names:
* Franklin
* Templeton
* Mutual Series
* Bissett
* Fiduciary Trust
* Darby Overseas
Our sponsored investment products include a broad range of global/international equity, Domestic (U.S.) equity, hybrid, 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 or our clients. These arrangements could change in the future.
Our secondary business and operating segment is banking/finance. Our banking/finance group offers selected retail-banking services to high net-worth individuals, foundations and institutions, and consumer lending 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
DECEMBER 31, PERCENT
(in millions except per share data) 2004 2003 CHANGE
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NET INCOME $240.0 $172.3 39%
EARNINGS PER SHARE
Basic $0.96 $0.70 37%
Diluted 0.92 0.67 37%
OPERATING MARGIN 30% 28% --
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Net income increased 39% in the three months ended December 31, 2004, as compared to the same period last year, due primarily to higher investment management and underwriting and distribution fees reflecting a 20% increase in simple monthly average assets under management and a 19% increase in gross sales over the same period last year. The increase was partly offset by higher operating expenses including underwriting and distribution and compensation and benefits expenses.
ASSETS UNDER MANAGEMENT
(in billions) DECEMBER 31, 2004 DECEMBER 31, 2003
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EQUITY
Global/international $155.7 $118.5
Domestic (U.S.) 73.3 63.6
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Total equity 229.0 182.1
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HYBRID 66.4 51.1
FIXED-INCOME
Tax-free 51.8 52.4
Taxable
Domestic (U.S.) 32.5 32.2
Global/international 16.3 13.1
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Total fixed-income 100.6 97.7
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MONEY MARKET 6.2 5.8
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TOTAL $402.2 $336.7
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SIMPLE MONTHLY AVERAGE FOR THE THREE-MONTH PERIOD (1) $381.0 $318.7
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(1) Investment management fees from approximately 37% of our assets under
management at December 31, 2004 were calculated using a daily average.
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Our assets under management at December 31, 2004 were $402.2 billion, 19% higher than they were a year ago, primarily due to excess sales over redemptions of $23.9 billion and market appreciation of $44.2 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 20% for the three months ended December 31, 2004 over the same period a year ago.
The simple monthly average mix of assets under management is shown below.
THREE MONTHS ENDED
DECEMBER 31,
2004 2003
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Equity 56% 53%
Fixed-income 26% 30%
Hybrid 16% 15%
Money market 2% 2%
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TOTAL 100% 100%
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For the three months ended December 31, 2004, our effective investment management fee rate (investment management fees divided by simple monthly average assets under management) increased to 0.595% from 0.570% in the same period last year. The change in the mix of assets under management, resulting from higher relative excess sales over redemptions, appreciation of equity as compared to fixed-income products, and an increase in performance fees led to an increase in our effective investment management fee rate. Generally, management fees earned on equity products are higher than fees earned on fixed-income products.
Assets under management by sales office location were as follows:
DECEMBER 31, % OF SEPTEMBER 30, % OF
(in billions) 2004 TOTAL 2004 TOTAL
---------------------------------------------- ------------------- --------- --------------- --------
United States $291.7 73% $265.3 73%
Canada 29.4 7% 25.8 7%
Europe 36.2 9% 29.5 8%
Asia/Pacific and other /1 44.9 11% 41.3 12%
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TOTAL $402.2 100% $361.9 100%
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/1 Includes multi-jurisdictional assets under management.
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Components of the change in our assets under management were as follows:
THREE MONTHS ENDED
DECEMBER 31, PERCENT
(in billions) 2004 2003 CHANGE
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Beginning assets under management $361.9 $301.9 20%
Sales 28.4 23.8 19%
Reinvested distributions 4.3 1.9 126%
Redemptions (19.6) (16.4) 20%
Distributions (5.4) (2.7) 100%
Acquisitions -- 0.9 (100%)
Appreciation 32.6 27.3 19%
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ENDING ASSETS UNDER MANAGEMENT $402.2 $336.7 19%
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For the three months ended December 31, 2004, excess sales over redemptions were $8.8 billion, as compared to $7.4 billion in the same period last year. Market appreciation of $32.6 billion in the three months ended December 31, 2004 related primarily to our equity and hybrid products.
OPERATING REVENUES
THREE MONTHS ENDED
DECEMBER 31, PERCENT
(in millions) 2004 2003 CHANGE
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Investment management fees $566.5 $454.5 25%
Underwriting and distribution fees 340.4 276.3 23%
Shareholder servicing fees 63.1 61.3 3%
Consolidated sponsored investment products income, net 0.6 -- N/A
Other, net 15.4 17.6 (13%)
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TOTAL OPERATING REVENUES $986.0 $809.7 22%
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INVESTMENT MANAGEMENT FEES
Investment management fees, accounting for 57% of our operating revenues for the three months ended December 31, 2004, as compared to 56% for the same period last year, include both investment advisory and administration fees. 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.
Investment management fees increased 25% for the three months ended December 31, 2004, as compared to the same period last year, consistent with a 20% increase in simple monthly average assets under management and
an increase in our effective investment management 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 share classes and for sales to shareholders or intermediaries that exceed specified minimum amounts. Therefore, underwriting fees will change with overall level of gross sales, the size of individual 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 advisers 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 23% for the three months ended December 31, 2004 compared to the same period last year. For the three months ended December 31, 2004, commission revenues increased 15% from the same period last year consistent with a 19% increase in gross sales, partially offset by the discontinuation of front-end sales charges on Class C shares sold in the United States effective January 1, 2004. Distribution fees increased 32% for the three months ended December 31, 2004 over the same period last year consistent with a 20% increase in simple monthly average assets under management and a shift in the asset and share class 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 fees as compensation 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 at a reduced rate through the second quarter of the following calendar year. 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. Shareholder servicing fees increased 3% for the three months ended December 31, 2004 from the same period last year consistent with an increase in billable shareholder accounts.
CONSOLIDATED SPONSORED INVESTMENT PRODUCTS INCOME, NET
Consolidated sponsored investment products income, net reflects the net operating income of majority-owned sponsored investment products, including dividends received. The increase for the three months ended December 31, 2004, as compared to the same period last year, reflects an increase in the number of products that have been consolidated in our results of operations.
OTHER, NET
Other, net consists primarily of revenues from the banking/finance operating segment as well as 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 interest expense and the provision for probable loan losses.
Other, net decreased 13% in the three months ended December 31, 2004 from the same period last year due to lower realized gains on sales of automotive loans, lower interest income on loans held for sale, and lower interest income on investments, partially offset by a decrease in interest on deposits and the decline in provision for probable loan losses primarily related to our automotive portfolio.
OPERATING EXPENSES
THREE MONTHS ENDED
DECEMBER 31, PERCENT
(in millions) 2004 2003 CHANGE
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Underwriting and distribution $311.4 $248.7 25%
Compensation and benefits 211.5 189.2 12%
Information systems, technology and occupancy 66.8 69.7 (4%)
Advertising and promotion 26.1 21.2 23%
Amortization of deferred sales commissions 31.4 22.5 40%
Amortization of intangible assets 4.4 4.4 --
Other 34.3 31.1 10%
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TOTAL OPERATING EXPENSES $685.9 $586.8 17%
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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 25% for the three months ended December 31, 2004 over the same period last year consistent with similar trends in underwriting and distribution revenue.
COMPENSATION AND BENEFITS
Compensation and benefits expense increased 12% for the three months ended December 31, 2004 compared to the same period last year. The increase resulted primarily from an increase in bonus expense under our Amended and Restated Annual Incentive Compensation Plan, which awards cash and stock bonuses based, in part, on our performance, as well as under other performance-based plans. In addition, we experienced increases related to annual merit salary adjustments effective in October 2004 and to other employee benefits. We employed approximately 6,800 people at December 31, 2004 as compared to about 6,500 at December 31, 2003.
INFORMATION SYSTEMS, TECHNOLOGY AND OCCUPANCY
Information systems, technology and occupancy costs decreased 4% during the three months ended December 31, 2004. This decrease was primarily due to lower depreciation levels related to a decrease in purchases of information system and technology equipment as certain of our technology equipment is periodically replaced under our technology outsourcing agreement, as well as lower expenditures on software due to the stabilization in the number and scope of new technology project initiatives. The decline in information systems and technology expense was partly offset by an increase in building costs related to global expansion.
Details of capitalized information systems and technology costs were as follows:
THREE MONTHS ENDED
DECEMBER 31,
(in millions) 2004 2003
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Net book value at beginning of period $51.3 $79.2
Additions during period, net of disposals and other adjustments 2.9 7.3
Net assets added through acquisitions -- 0.3
Amortization during period (7.3) (13.0)
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NET CARRYING AMOUNT AT END OF PERIOD $46.9 $73.8
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ADVERTISING AND PROMOTION
Advertising and promotion expense increased 23% for the three months ended December 31, 2004 over the same period last year due to higher expenditures on direct advertising campaigns and marketing materials. 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.
AMORTIZATION OF DEFERRED SALES COMMISSIONS
Certain fund share classes, including Class B, are sold without a front-end sales charge to shareholders, although our distribution subsidiaries pay a commission on the sale. Furthermore, in the United States, Class A shares are sold without a front-end sales charge to shareholders when minimum investment criteria are met, and Class C shares are sold without a front-end sales charge since January 1, 2004. However, our U.S. distribution subsidiary pays a commission on these sales. We defer and amortize all up-front commissions paid by our distribution subsidiaries and amortize them over 12 months to 8 years depending on share class or financing arrangements.
Class B and certain of our Class C deferred commission assets ("DCA") arising from our U.S., Canadian and European operations are financed through Lightning Finance Company Limited ("LFL"), a company in which we have a 49% ownership interest. 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 retain DCA sold to LFL under the U.S. agreement in our financial statements 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 direct agreements with our Canadian and European sponsored investment products, and, as a result, we do not record DCA from these sources in our financial statements. The boards of the U.S. funds that offer Class B shares have approved a proposal to cease the offering of Class B shares to new investors and existing shareholders desiring to make additional purchases. Existing Class B shareholders would continue to be permitted to exchange shares into Class B shares of different funds. Existing Class B shareholders would also be permitted to continue to reinvest dividends in additional Class B shares. The cessation of purchases of Class B shares by new investors and existing shareholders will be effective in the first calendar quarter of 2005 and may have a negative effect on the overall sales of the funds' shares.
Amortization of deferred sales commissions increased 40% for the three months ended December 31, 2004 over the same period last year principally due to a 19% increase in gross product sales and because LFL has not sold U.S. DCA in a securitization transaction since fiscal 2002.
OTHER INCOME (EXPENSES)
Other income (expenses) includes net realized and unrealized investment gains (losses) of consolidated sponsored investment products, investment and other income, net and interest expense. Investment and other income, net is comprised primarily of income related to our investments, including dividends, interest income, realized gains and losses and income from investments accounted for using the equity method of accounting, as well as minority interest expense and foreign currency exchange gains and losses.
Other income (expenses) increased 172% during the three months ended December 31, 2004 from the same period last year primarily due to higher realized and unrealized net gains from our consolidated sponsored investment products, net of related minority interest expense, higher interest income from term deposits and debt securities and higher equity method income from our investments.
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 locations outside the United States. Some of these jurisdictions have lower tax rates than the United States. The mix of pre-tax income (primarily from our investment management business) subject to these lower 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 months ended December 31, 2004 was 28.5% and remained substantially unchanged from 29% for the same period last year. 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.
LIQUIDITY AND CAPITAL RESOURCES
The following table summarizes certain key financial data relating to our liquidity, and sources and uses of capital:
DECEMBER 31, SEPTEMBER 30,
(in millions) 2004 2004
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BALANCE SHEET DATA
Assets
Liquid assets $4,528.9 $4,279.3
Cash and cash equivalents 3,105.2 2,917.2
Liabilities
Federal funds purchased and Federal Home Loan Bank Advances $0.2 $6.0
Commercial paper 170.0 170.0
Convertible Notes 532.6 530.1
Medium Term Notes 420.0 420.0
Other long-term debt 263.2 246.3
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Total debt $1,386.0 $1,372.4
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THREE MONTHS ENDED
DECEMBER 31,
2004 2003
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CASH FLOW DATA
Operating cash flows $239.9 $94.7
Investing cash flows (53.1) 133.4
Financing cash flows 1.2 70.9
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Liquid assets, which consist of cash and cash equivalents, investments (trading and available-for-sale) and current receivables, increased from September 30, 2004, primarily due to cash provided by operating activities. Cash and cash equivalents include cash, debt instruments with maturities of three months or less at the purchase date and other highly liquid investments that are readily convertible into cash, including money market funds. Cash and cash equivalents increased from September 30, 2004 as we invested operating cash flows in debt instruments, including term deposits, U.S. T-bills and other interest-bearing deposits, with maturities of three months or less from the purchase date.
The increase in total debt outstanding from September 30, 2004 relates primarily to an increase in long-term financing liability recognized in relation to U.S. DCA financed by LFL.
We experienced higher operating cash flows for the three months ended December 31, 2004 as compared to the same period last year due to higher net income and net proceeds from the securitization of loans held for sale. The decline in investing cash flows for the three months ended December 31, 2004 as compared to the same period last year related primarily to excess purchases of investments over liquidations. Financing activities in the three months ended December 31, 2004 included the purchase and retirement of 1.8 million shares at a cost of $117.7 million. At December 31, 2004, approximately 11.5 million shares remained available for repurchase under board authorizations. We purchased and retired 0.3 million shares at a cost of $12.5 million during the three months ended December 31, 2003.
CAPITAL RESOURCES
We believe that we can meet our present and reasonably foreseeable operating cash needs and future commitments through existing liquid assets, continuing cash flows from operations, borrowing capacity under current credit facilities, the ability to issue debt or equity securities, and mutual fund sales commission financing arrangements. In particular, we expect to finance future investment in our banking/finance activities through operating cash flows, debt, increased deposit base, and through the securitization of a portion of the receivables from consumer lending activities.
As of December 31, 2004, we had $300.0 million of debt and equity securities available to be issued under shelf registration statements filed with the SEC and $330.0 million of additional commercial paper available for issuance. Our committed revolving credit facilities at December 31, 2004 totaled $420.0 million, of which, $210.0 million was under a 364-day facility expiring in June 2005. The remaining $210.0 million facility is under a five-year facility that will expire in June 2007. In addition, at December 31, 2004, our banking/finance operating segment had $511.5 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 investment management segment finances Class B and certain Class C DCA arising from our U.S., Canadian and European operations through LFL, a company in which we have a 49% ownership interest. Class B and C sales commissions that we have financed globally through LFL during the three months ended December 31, 2004, were approximately $42.7 million compared to $43.3 million during the three months ended December 31, 2003. LFL's ability to access credit facilities and the securitization market will directly affect our existing financing arrangements.
Our banking/finance operating segment finances its automotive lending activities through operational cash flows, inter-segment loans and by selling its auto loans in securitization transactions with qualified special purpose entities, which then issue asset-backed securities to private investors. Beginning in calendar year 2005, automotive lending activities may also be financed by issuing auto loan backed variable funding notes to institutional investors, and as a result, we expect that inter-segment lending activities will decrease. Gross sale proceeds from auto loan securitization transactions were $178.8 million for the three months ended December 31, 2004 and $185.1 million in the three months ended December 31, 2003. Our ability to access the securitization market will directly affect our plans to finance the auto loan portfolio in the future.
USES OF CAPITAL
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 technology infrastructure and business processes, pay shareholder dividends and repay and service debt.
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. To date, we have 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. We may redeem the remaining Convertible Notes for cash on or after May 11, 2006 or, at the option of the holders, we may be required to make additional repurchases on May 11 of 2006, 2011, 2016, 2021 and 2026. In this event, we may choose to pay the accreted value of the Convertible Notes in cash or shares of our common stock. The amount that the holders may redeem in the future will depend on, among other factors, the performance of our common stock.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
Our contractual obligations are summarized in our Annual Report on Form 10-K for the year ended September 30, 2004. As of December 31, 2004, there had been no material changes in our contractual obligations from September 30, 2004.
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 December 31, 2004, the maximum potential amount of future payments related to these obligations was $29.5 million. In addition, our Consolidated Balance Sheet at December 31, 2004 included a $0.5 million liability to reflect the fair value of certain additional obligations arising from auto securitization transactions.
At December 31, 2004, the banking/finance operating segment had commitments to extend credit aggregating $241.2 million, primarily under its credit card lines, and had issued financial standby letters of credit totaling $2.6 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 $2.2 million as of December 31, 2004 and commercial real estate.
OFF-BALANCE SHEET ARRANGEMENTS
As discussed above, we obtain financing for sales commissions that we pay to broker/dealers on Class B and certain Class C shares of our sponsored investment products through LFL, a company established in Ireland to provide DCA financing. We hold a 49% ownership interest in LFL and we account for this ownership interest using the equity method of accounting. Our exposure to loss related to our investment in LFL is limited to the carrying value of our investment and loans, and interest and fees receivable from LFL. At December 31, 2004, those amounts approximated $55.7 million. During the three months ended December 31, 2004, we recognized pre-tax income of approximately $2.5 million for our share of its net income 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 $844.8 million at December 31, 2004 and $768.9 million at September 30, 2004.
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, 2004.
GOODWILL AND OTHER INTANGIBLE ASSETS
We make significant estimates and assumptions when valuing goodwill and other intangibles in connection with the initial purchase price allocation of an acquired entity, as well as when evaluating impairment of intangibles on an ongoing basis.
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. Goodwill impairment is indicated when the carrying amount of a reporting unit exceeds its implied fair value, calculated based on anticipated discounted cash flows. 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 impairment on the basis of the expected future undiscounted operating cash flows, without interest charges, to be derived from these assets. We review
definite-lived intangible assets for impairment when there is an indication of impairment, or at least once a year.
We completed our latest annual impairment test of goodwill and indefinite-lived and definite-lived intangible assets during the quarter ended March 31, 2004 and we determined that there was no impairment to these assets as of October 1, 2003.
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. As of December 31, 2004, and based on tax laws in effect as of this date, it is our intention to continue to indefinitely reinvest the undistributed earnings of foreign subsidiaries. As a result, we have not made a provision for U.S. taxes and have not recorded a deferred tax liability on $2.6 billion of cumulative undistributed earnings recorded by foreign subsidiaries as of December 31, 2004. Changes to our policy of reinvesting foreign earnings may have a significant effect on our financial condition and results of operation.
In December 2004, the FASB issued Staff Position No. 109-2, "Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004" ("FSP FAS 109-2"). The American Jobs Creation Act of 2004 (the "Act") was signed into law on October 22, 2004. Under a provision of the Act, we may elect to repatriate certain earnings of our foreign-based subsidiaries at a reduced federal tax rate in either of our fiscal years ending September 30, 2005 or September 30, 2006. FSP FAS 109-2 provides guidance on when an enterprise should recognize in its financial statements the effects of the one-time tax benefit of repatriation of foreign earnings under the Act, and specifies interim disclosure requirements. We are currently evaluating the effect of this repatriation provision; however, we do not expect to complete this evaluation until after the U.S. Congress or the U.S. Department of the Treasury issue additional guidance regarding this provision. The range of possible amounts we are considering for repatriation is between zero and $1.9 billion, and the potential range of income tax associated with amounts subject to the reduced rate is between zero and $117.0 million.
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 for other-than-temporary decline in value on a periodic basis. This may exist when the fair value of an investment security has been below the current value for an extended period of 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 is determined. We classify securities as trading when it is management's intent at the time of purchase to sell the security within a short period of time. Accordingly, we record unrealized gains and losses on these securities in our consolidated income.
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.
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 December 31, 2004 to provide for any probable losses that may arise from these matters. See also "Legal Proceedings " included in Part II, Item 1 of this report.
VARIABLE INTEREST ENTITIES
Under FIN 46-R, a variable interest entity ("VIE") is an entity in which the equity investment holders have not contributed sufficient capital to finance its activities 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 if we qualify as the primary beneficiary of these VIEs, is highly complex and involves the use of estimates and assumptions. To determine our interest in the expected losses or residual returns of each VIE, we performed an expected cash flow analysis using certain discount rate and volatility assumptions based on available historical information and management's estimates. Based on our analysis, we did not consolidate any VIEs in our financial statements as of December 31, 2004. While we believe that our testing and approach were appropriate, future changes in estimates and assumptions may affect our decision and lead to the consolidation of one or more VIEs in our financial statements.
IMPACT OF INFLATION
Our Consolidated Financial Statements and related Notes are presented in historical dollars without considering the effect of inflation. Since a significant portion of our assets are liquid in nature, the potential effect of inflation is mitigated. In addition, the majority of our revenues and related expenses are denominated in U.S. dollars, a currency that has not been significantly affected by the impact of changes in prices in recent years. To the extent that a potential rise in inflation may affect the securities and the consumer lending markets, it may adversely affect our financial position and results of operation in the future.
RISK FACTORS
WE FACE STRONG COMPETITION FROM NUMEROUS AND SOMETIMES LARGER COMPANIES WITH COMPETING OFFERINGS AND PRODUCTS. We compete with numerous investment management companies, mutual fund, 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 broker/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 broker/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. Our ability to attract and retain assets under our management is also dependent on the relative investment performance of our funds and other managed investment portfolios and our ability to maintain our investment management and administrative fees at competitive levels.
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 advisers. Increasing competition for these distribution channels and recent regulatory initiatives, have 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 advisers who distributes our products were to cease its operations, it could have a significant adverse impact on our revenues and earnings. Moreover, our failure to maintain strong business relationships with these advisers 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 FINANCIAL AND EQUITY MARKETS. We have become subject to an increased risk of asset volatility from changes in the 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 IMPACT REVENUES, ARE SUBJECT TO SIGNIFICANT FLUCTUATIONS. Global economic conditions, changes in the equity market place, currency exchange rates, 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.
OUR FUTURE RESULTS ARE DEPENDENT UPON MAINTAINING AN APPROPRIATE LEVEL OF EXPENSES, WHICH ARE SUBJECT TO FLUCTUATION. The level of our expenses are subject to fluctuation and may increase for the following or other reasons: an increase in insurance expenses including through the assumption of higher deductibles and/or co-insurance liability; changes in the level and scope of our advertising expenses in response to market conditions; variations in the level of total compensation expense due to, among other things, bonuses, changes in our employee count and mix, and competitive factors; expenses and capital costs, including costs incurred to maintain and enhance our administrative and operating services infrastructure.
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 which may involve increased expense and capital costs. Regulators in these jurisdictions could also 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 ABILITY TO MEET CASH NEEDS DEPENDS UPON CERTAIN FACTORS, INCLUDING OUR ASSET VALUE, CREDIT WORTHINESS AND THE MARKET VALUE OF OUR STOCK. 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 certain Class 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.
OUR REVENUES COULD BE ADVERSELY AFFECTED IF THE TERMS OF OUR INVESTMENT MANAGEMENT AGREEMENTS ARE SIGNIFICANTLY ALTERED OR THESE AGREEMENTS ARE TERMINATED BY THE FUNDS WE ADVISE. Our revenues are dependent on fees earned under investment management or related administrative agreements that we have with the funds we advise. These revenues could be adversely affected if the terms of these agreements are significantly altered or these agreements are terminated.
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 EXTENSIVE REGULATION DOMESTICALLY AND ABROAD. Our investment management business and other businesses are subject to extensive regulation in the United States and abroad, including, among others, securities, banking, accounting and tax laws and regulations. We are subject to Federal securities laws, state laws regarding securities fraud, other Federal and State regulations promulgated by the Securities and Exchange Commission, the National Association of Securities Dealers and the New York Stock Exchange, and to the extent operations take place outside the United States, by foreign regulations and regulators. During the past five years, the Federal securities laws have been augmented substantially by, among other measures, the Sarbanes-Oxley Act of 2002 and the USA Patriot Act. 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 (the "FRB"). We are subject to the restrictions, limitations, or prohibitions of the Bank Holding Company Act of 1956 and the Gramm-Leach-Bliley Act. The FRB may impose additional limitations or restrictions on our activities, including if the FRB believes that we do not have the appropriate financial and managerial resources to commence or conduct an activity or make an acquisition.
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 OUR PROFITABILITY AND FUTURE FINANCIAL RESULTS. Current and pending regulatory and legislative actions and reforms affecting the mutual fund industry, including compliance initiatives, may negatively impact revenues, either of which could have a material negative impact on our financial results.
TECHNOLOGY AND OPERATING RISK AND LIMITATIONS COULD CONSTRAIN OUR OPERATIONS. We are highly dependent on the integrity of our technology, operating systems and premises. Although we have in place certain disaster recovery plans, we may experience system delays and interruptions as a result of natural disasters, power failures, acts of war, and third party failures, which could negatively impact our operations.
GOVERNMENTAL INVESTIGATIONS, SETTLEMENTS OF SUCH INVESTIGATIONS, ONGOING AND PROPOSED GOVERNMENTAL ACTIONS, AND REGULATORY EXAMINATIONS OF FRANKLIN RESOURCES, INC. AND CERTAIN OF ITS SUBSIDIARIES (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.
INVESTIGATIONS. As part of various investigations by a number of federal, state and foreign regulators, including the Securities and Exchange Commission ("SEC"), the California Attorney General's Office ("CAGO"), and the National Association of Securities Dealers, Inc. ("NASD"), relating to certain practices in the mutual fund industry, including late trading, market timing and marketing support payments to securities dealers who sell fund shares, the Company, as well as certain current or former executives and employees of the Company, received subpoenas and/or requests for documents, information and/or testimony. The Company and its current employees provided documents and information in response to those requests and subpoenas.
Franklin Templeton Investments Corp. ("FTIC"), a Company subsidiary and the investment manager of Franklin Templeton's Canadian mutual funds, has been cooperating with and responding to requests for information from the Ontario Securities Commission (the "OSC") relating to the OSC's review of frequent trading practices within the Canadian mutual fund industry. On December 10, 2004, FTIC received a letter indicating that the staff of the OSC is contemplating enforcement proceedings against FTIC before the OSC. In its letter, the OSC staff expressed the view that, over the period of February 1999 to February 2003, there were certain accounts that engaged in a frequent trading market timing strategy in certain funds being managed by FTIC. The letter also gave FTIC the opportunity to respond to the issues raised in the letter and to provide the OSC staff with additional information relevant to those matters. The Company has entered into discussions with the OSC staff in an effort to resolve the issues raised in the OSC's review. The Company cannot predict the likelihood of whether those discussions will result in a settlement or the terms or amount of any such settlement. Should a settlement be reached, the amount could be material to the Company's financial results.
On December 9, 2004, the enforcement staff of the NASD informed the Company that it had made a preliminary determination to recommend a disciplinary proceeding against Franklin/Templeton Distributors, Inc. ("FTDI"), alleging that FTDI violated certain NASD rules by the use of directed brokerage commissions to pay for sales and marketing support. The enforcement staff has since advised the Company that it has determined not to recommend a disciplinary proceeding against FTDI and has concluded its investigation of
this matter. Separately, FTDI has also received a letter from the NASD staff advising of its preliminary determination to recommend a disciplinary proceeding against FTDI alleging violation of certain NASD rules relating to FTDI's Top Producers program. The Company believes that any such charges are unwarranted and has responded with a submission as to why such action is not warranted. As of the date of this filing, the NASD staff has not taken any further action.
SETTLEMENTS. Beginning in August 2004, the Company entered into settlements with certain regulators investigating the mutual fund industry practices noted above. The Company believes that settlement of each of the matters described in this section is in the best interest of the Company and shareholders of the Franklin Templeton mutual funds (the "Funds").
On August 2, 2004, Franklin Resources, Inc. announced that its subsidiary, Franklin Advisers, Inc. ("Franklin Advisers") reached an agreement with the SEC that resolved the issues resulting from the previously disclosed SEC investigation into market timing activity. In connection with that agreement, the SEC issued an "Order Instituting Administrative and Cease-and-Desist Proceedings Pursuant to Sections 203(e) and 203(k) of the Investment Advisers Act of 1940 and Sections 9(b) and 9(f) of the Investment Company Act of 1940, Making Findings and Imposing Remedial Sanctions and a Cease-and-Desist Order" (the "Order"). The SEC's Order concerned the activities of a limited number of third parties that ended in 2000 and those that were the subject of the first Massachusetts administrative complaint described below.
Under the terms of the SEC's Order, pursuant to which Franklin Advisers neither admitted nor denied any of the findings contained therein, Franklin Advisers agreed to pay $50 million to be distributed to shareholders of certain of the Funds, of which $20 million was a civil penalty. The settlement and related legal and distribution costs of $60 million ($45.6 million, net of taxes) were recorded as a charge to income in the fiscal quarter ended March 31, 2004.
The Order required Franklin Advisers to, among other things:
* Enhance and periodically review compliance policies and procedures, and
establish a corporate ombudsman;
* Establish a new internal position whose responsibilities shall include
compliance matters related to conflicts of interests; and
* Retain an Independent Distribution Consultant to develop a plan to
distribute the $50 million settlement to Fund shareholders.
The Order further provided that in any related investor actions, Franklin Advisers would not benefit from any offset or reduction of any investor's claim by the amount of any distribution from the above-described $50 million to such investor that is proportionately attributable to the civil penalty paid by Franklin Advisers.
On September 20, 2004, Franklin Resources, Inc. announced that two of its subsidiaries, Franklin Advisers and Franklin Templeton Alternative Strategies, Inc. ("FTAS"), reached an agreement with the Securities Division of the Office of the Secretary of the Commonwealth of Massachusetts (the "State of Massachusetts") related to its administrative complaint filed on February 4, 2004, concerning one instance of market timing that was also a subject of the August 2, 2004 settlement that Franklin Advisers reached with the SEC, as described above. Under the terms of the settlement consent order issued by the State of Massachusetts, Franklin Advisers and FTAS consented to the entry of a cease-and-desist order and agreed to pay a $5 million administrative fine to the State of Massachusetts (the "Massachusetts Consent Order"). The Company recorded this expense in the quarter ended September 30, 2004. The Massachusetts Consent Order included two different sections: "Statements of Fact" and "Violations of Massachusetts Securities Laws." Franklin Advisers and FTAS admitted the facts in the Statements of Fact.
On October 25, 2004, the State of Massachusetts filed a second administrative complaint, alleging that Franklin Resources, Inc.'s Form 8-K filing (in which it described the Massachusetts Consent Order and stated that "Franklin did not admit or deny engaging in any wrongdoing") failed to state that Franklin Advisers and FTAS admitted the Statements of Fact portion of the Massachusetts Consent Order (the "Second Complaint"). Franklin Resources, Inc. reached a second agreement with the State of Massachusetts on November 19, 2004, resolving the Second Complaint. As a result of the November 19, 2004 settlement, Franklin Resources, Inc. filed a new Form 8-K. The terms of the Massachusetts Consent Order did not change and there was no monetary fine associated with this second settlement.
On November 17, 2004, Franklin Resources, Inc. announced that FTDI reached an agreement with the CAGO, resolving the issues resulting from the CAGO's investigation concerning sales and marketing support payments. Under the terms of the settlement, FTDI neither admitted nor denied the allegations in the CAGO's complaint and agreed to pay $2 million to the State of California as a civil penalty, $14 million to the Funds, to be allocated by an independent distribution consultant to be paid for by FTDI, and $2 million to the CAGO for its investigative costs. The Company's results for the quarter and fiscal year ended September 30, 2004 included a charge to income of $18.5 million ($12.2 million, net of tax) related to this settlement.
On December 13, 2004, Franklin Resources, Inc. announced that its subsidiaries FTDI and Franklin Advisers reached an agreement with the SEC, resolving the issues resulting from the SEC's investigation concerning marketing support payments to securities dealers who sell Fund shares. In connection with that agreement, the SEC issued an "Order Instituting Administrative and Cease-and-Desist Proceedings, Making Findings, and Imposing Remedial Sanctions Pursuant to Sections 203(e) and 203(k) of the Investment Advisers Act of 1940, Sections 9(b) and 9(f) of the Investment Company Act of 1940, and Section 15(b) of the Securities Exchange Act of 1934" (the "Second Order").
Under the terms of the Second Order, in which FTDI and Franklin Advisers neither admitted nor denied the findings contained therein, they agreed to pay the Funds a penalty of $20 million and disgorgement of $1 (one dollar). FTDI and Franklin Advisers also agreed to implement certain measures and undertakings relating to marketing support payments to broker-dealers for the promotion or sale of Fund shares, including making additional disclosures in the Funds' Prospectuses and Statements of Additional Information. The Second Order further requires the appointment of an independent distribution consultant, at the Company's expense, who shall develop a plan for the distribution of the penalty and disgorgement to the Funds. The Company recorded a charge of $21.5 million ($17.3 million, net of taxes) in its fiscal quarter ended June 30, 2004 related to this matter.
INTERNAL INQUIRIES. The Company also conducted its own internal fact-finding inquiry with the assistance of outside counsel to determine whether any Fund shareholders, 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 complete. We did not find any late trading, though we identified various instances of frequent trading. One officer of a subsidiary of Franklin Resources, Inc. was placed on administrative leave and subsequently resigned from his position with the Company in December 2003.
The Company found no instances of inappropriate mutual fund trading by any portfolio manager, investment analyst or officer of Franklin Resources, Inc. As previously disclosed, the Company 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. 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 reinstated the trader. The independent counsel concluded that some instances of the former Fund officer's trading violated Company policy, and the Company was prepared to institute appropriate disciplinary action. Subsequently, the former Fund officer resigned from his employment with 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 action and other lawsuits 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 possible that the Company may be named in additional similar civil actions.
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 including those 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.
Our banking/finance operating segment is exposed to interest rate fluctuations on its loans receivable, debt securities held, and deposit liabilities. 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 December 31, 2004, we have considered the potential impact of the effect on the banking/finance operating segment balances, 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.
Our investment management operating segment is exposed to changes in interest rates through its investment in debt securities and its outstanding debt. We minimize the impact of interest rate fluctuations related to our investments in debt securities by managing the maturities of these securities, and through diversification. Our exposure to interest rate changes related to our debt issuances is not material since a significant percentage of our outstanding debt is at fixed interest rates.
We are subject to foreign exchange risk through our foreign operations. 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. Our exposure to foreign exchange risk is minimized since a significant portion of these revenues and associated expenses are denominated in U.S. dollars. This situation may change in the future as our business continues to grow outside the United States.
We are exposed to equity price fluctuations through securities we hold that are carried at fair value and through investments held by majority-owned sponsored investment products that we consolidate. To mitigate this risk, we maintain a diversified investment portfolio. Our exposure to equity price fluctuations is also minimized as we sponsor a broad range of investment products in various global jurisdictions.
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 December 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 December 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 December 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 September 20, 2004, Franklin Resources, Inc. announced that two of its subsidiaries, Franklin Advisers and Franklin Templeton Alternative Strategies, Inc. ("FTAS"), reached an agreement with the Securities Division of the Office of the Secretary of the Commonwealth of Massachusetts (the "State of Massachusetts") related to its administrative complaint filed on February 4, 2004, concerning one instance of market timing that was also a subject of the August 2, 2004 settlement that Franklin Advisers reached with the SEC, as described 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 ("Note 13"). Under the terms of the settlement consent order issued by the State of Massachusetts, Franklin Advisers and FTAS consented to the entry of a cease and desist order and agreed to pay a $5 million administrative fine to the State of Massachusetts (the "Massachusetts Consent Order"). Franklin Resources, Inc. and certain of its subsidiaries (as used in this section, together, the "Company") recorded this expense in the quarter ended September 30, 2004. The Massachusetts Consent Order included two different sections: "Statements of Fact" and "Violations of Massachusetts Securities Laws." Franklin Advisers and FTAS admitted the facts in the Statements of Fact.
On October 25, 2004, the State of Massachusetts filed a second administrative complaint, alleging that Franklin Resources, Inc.'s Form 8-K filing (in which it described the Massachusetts Consent Order and stated that "Franklin did not admit or deny engaging in any wrongdoing") failed to state that Franklin Advisers and FTAS admitted the Statements of Fact portion of the Massachusetts Consent Order (the "Second Complaint"). Franklin Resources, Inc. reached a second agreement with the State of Massachusetts on November 19, 2004, resolving the Second Complaint. As a result of the November 19, 2004 settlement, Franklin Resources, Inc. filed a new Form 8-K. The terms of the original settlement did not change and there was no monetary fine associated with this second settlement.
In addition, the Company and certain Funds, current and former officers, employees, and directors have been named in multiple lawsuits in different federal courts in Nevada, California, Illinois, New York, and Florida, alleging violations of various federal securities laws and seeking, among other relief, monetary damages, restitution, removal of Fund trustees, directors, advisers, administrators, and distributors, rescission of management contracts and 12b-1 Plans, and/or attorneys' fees 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 Franklin Resources, Inc. subsidiaries, resulting in alleged market timing activity. The majority of these lawsuits duplicate, in whole or in part, the allegations asserted in the February 4, 2004 Massachusetts administrative complaint and the findings in the SEC's August 2, 2004 Order, as described in Note 13. The lawsuits are styled as class actions, or derivative actions on behalf of either the named Funds or Franklin Resources, Inc.
To date, more than 240 similar lawsuits against at least 19 different mutual fund companies have been filed in federal district courts 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 in the United States District Court for the District of Maryland, entitled "In re Mutual Funds Investment Litigation" (the "MDL"). The Judicial Panel then transferred similar cases from different districts to the MDL for coordinated or consolidated pretrial proceedings.
As of February 8, 2005, the following federal lawsuits are pending against the Company (and in some instances, against certain officers, directors and/or Funds) and have been 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; 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; 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; 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; D'Alliessi 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; 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.
Plaintiffs in the MDL filed consolidated amended complaints on September 29, 2004. It is anticipated that defendants will file motions to dismiss in the coming months, with a hearing scheduled for June 2005.
As previously reported, various subsidiaries of Franklin Resources, Inc., as well as certain Templeton Fund registrants, have also been named in multiple class action 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 seeking, among other relief, monetary damages and attorneys' fees and costs, 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 of 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 state court actions and are not subject to the MDL.
In addition, FTIC has been named in two class action market timing lawsuits in Canada, seeking, among other relief, monetary damages, an order barring any increase in management fees for a period of two years following judgment, and/or attorneys' fees and costs, as follows: Huneault v. AGF Funds, Inc., et al., Case No. 500-06-000256-046, filed on October 25, 2004 in the Superior Court for the Province of Quebec, District of Montreal, and Heinrichs, et al. v. CI Mutual Funds, Inc., et al., Case No. 04-CV-29700, filed on December 17, 2004 in the Ontario Superior Court of Justice.
As previously reported, the Company, 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/or payment of allegedly excessive advisory, commission, and distribution fees, and seeking, among other relief, monetary damages, restitution, rescission of advisory contracts, including recovery of all fees paid pursuant to those contracts, an accounting of all monies paid to the named advisers, declaratory relief, injunctive relief, and/or attorneys' fees and costs. These lawsuits are styled as class actions or 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 and transferred to the United States District Court for the District of New Jersey on August 5, 2004 (plaintiffs voluntarily dismissed this action, without prejudice, on October 22, 2004); Wilcox v. Franklin Resources, Inc., et al., Case No. 04-2258 WHW, filed on May 12, 2004 in the United States District Court for the District of New Jersey; Bahe, Custodian CGM Roth Conversion IRA v. Franklin/Templeton Distributors, Inc., et al., Case No. 04-11195 PBS, filed on June 3, 2004 in the United States District Court for the District of Massachusetts.
The United States District Court for the District of New Jersey consolidated for pretrial purposes three of the above lawsuits (Stephen Alexander IRA, Tricarico, and Wilcox) into a single action, entitled "In re Franklin Mutual Funds Fee Litigation." Plaintiffs in those three lawsuits filed a consolidated amended complaint (the "Complaint") on October 4, 2004. Defendants filed a motion to dismiss the Complaint on November 19, 2004. It is anticipated that the matter will be heard in the coming months.
Management strongly believes that the claims made in each of the lawsuits identified above are without merit and intends to vigorously defend against them. The Company cannot predict with certainty, however, the eventual outcome of the remaining governmental investigations or private 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, it is
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 its 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.
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 annual report on Form 10-K for the period ended September 30, 2004, as filed with the SEC on December 14, 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. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
The following table provides information with respect to the shares of common stock we repurchased during the three months ended December 31, 2004:
(c) TOTAL NUMBER OF (d) MAXIMUM NUMBER
SHARES PURCHASED AS OF SHARES THAT MAY
(a) TOTAL NUMBER PART OF PUBLICLY YET BE PURCHASED
OF SHARES (b) AVERAGE PRICE ANNOUNCED PLANS OR UNDER THE PLANS OR
PERIOD PURCHASED PAID PER SHARE PROGRAMS PROGRAMS
------------------------------- ------------------- -------------------- ---------------------- ----------------------
October 1, 2004 through 217,567 $55.55 217,567 13,013,516
October 31, 2004
November 1, 2004 through
November 30, 2004 -- -- -- 13,013,516
December 1, 2004 through
December 31, 2004 1,551,956 $68.07 1,551,956 11,461,560
------------ ------------
TOTAL 1,769,523 1,769,523
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Under a stock repurchase program authorized by our Board of Directors in September of 1985, 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 30.0 million shares, of which, 11.5 million shares remain available for repurchase as of December 31, 2004. Our stock repurchase program is not subject to an expiration date.
ITEM 6. EXHIBITS.
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 on 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 on 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 on February 2, 1994, incorporated by reference to Exhibit (3)(iv) to the 1994 Annual Report.
Exhibit 3(i)(e) Registrant's Certificate of Amendment of Certificate of Incorporation, as filed on February 4, 2005.
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 Form of 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 Exhibit 4 to the Registrant's
Registration Statement on Form S-3, filed with the
SEC 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 with the
SEC on August 6, 2001.
Exhibit 4.3 Form of Liquid Yield Option Note due 2031 (Zero
Coupon-Senior) incorporated by reference to Exhibit
4.2 to the Registrant's Registration Statement on
Form S-3, filed with the SEC on August 6, 2001.
Exhibit 4.4 Registration Rights Agreement between Franklin
Resources, Inc. and Merrill Lynch, Pierce, Fenner &
Smith Incorporated dated May 11, 2001, incorporated
by reference to Exhibit 4.4 to the Registrant's
Registration Statement on Form S-3, filed with the
SEC 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.
Exhibit 10.78 Form of Restricted Stock Award Agreement and Notice
of Restricted Stock Award under the Company's 2002
Universal Stock Incentive Plan, incorporated by
reference to the Company's Report on Form 8-K filed
with the SEC on November 12, 2004.*
Exhibit 10.79 Form of Stock Option Agreement and Notice of Stock
Option Grant under the Company's 2002 Universal
Stock Incentive Plan, incorporated by reference to
the Company's Report on Form 8-K filed with the SEC
on November 12, 2004.*
Exhibit 10.80 Form of Restricted Stock Award Agreement and Notice
of Restricted Stock Award under the Company's 2002
Universal Stock Incentive Plan, incorporated by
reference to the Company's Report on Form 8-K filed
with the SEC on November 19, 2004.*
Exhibit 10.81 Form of Restricted Stock Award Agreement and Notice
of Restricted Stock Unit Award under the Company's
2002 Universal Stock Incentive Plan, referenced in
the Company's Report on Form 8-K filed with the SEC
on November 19, 2004.*
Exhibit 10.82 Form of Restricted Stock Award Agreement and Notice
of Restricted Stock Award under the Company's 2002
Universal Stock Incentive Plan, incorporated by
reference to Exhibit 10.1 to the Company's Form 8-K
filed with the SEC on December 21, 2004.*
Exhibit 10.83 Franklin Resources, Inc. Deferred Compensation
Arrangement for Director's Fees, date as of January
21, 2005, by and between Franklin Resources, Inc. and
|
Samuel H. Armacost incorporated by reference to Exhibit 10.1 to the Company's Form 8-K filed with
the SEC on January 27, 2005.*
Exhibit 10.84 Franklin Resources, Inc. 2002 Universal Stock
Incentive Plan (as amended and restated December 16,
2004) incorporated by reference to Exhibit 10.2 to
the Company's Form 8-K filed with the SEC on January
27, 2005.*
Exhibit 10.85 Franklin Resources, Inc. Amended and Restated Annual
Incentive Compensation Plan (as amended and restated
December 16, 2004).*
Exhibit 10.86 Description of Non-Management Director's Compensation.*
Exhibit 10.87 Description of Performance Goals for the Company's
Co-Chief Executive Officers for the 2005 Fiscal Year
under the 2004 Key Executive Compensation Plan.*
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
(filed herewith).
Exhibit 31.2 Certification of Co-Chief Executive Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002
(filed herewith).
Exhibit 31.3 Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 (filed
herewith).
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).
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).
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* Management/Employment Contract or Compensatory Plan or Arrangement.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
FRANKLIN RESOURCES, INC.
(Registrant)
Date: February 8, 2005 By: /S/ JAMES R. BAIO
-------------------------------
James R. Baio
Senior Vice President and
Chief Financial Officer
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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 on 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 on 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 on February 2, 1994, incorporated by
reference to Exhibit (3)(iv) to the 1994 Annual Report.
Exhibit 3(i)(e) Registrant's Certificate of Amendment of Certificate of
Incorporation, as filed on February 4, 2005.
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 Form of 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 Exhibit 4 to the Registrant's Registration Statement on
Form S-3, filed with the SEC 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 with the SEC on August 6, 2001.
Exhibit 4.3 Form of Liquid Yield Option Note due 2031 (Zero
Coupon-Senior) incorporated by reference to Exhibit 4.2 to
the Registrant's Registration Statement on Form S-3, filed
with the SEC on August 6, 2001.
Exhibit 4.4 Registration Rights Agreement between Franklin Resources,
Inc. and Merrill Lynch, Pierce, Fenner & Smith Incorporated
dated May 11, 2001, incorporated by reference to Exhibit 4.4
to the Registrant's Registration Statement on Form S-3,
filed with the SEC 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.
Exhibit 10.78 Form of Restricted Stock Award Agreement and Notice of
Restricted Stock Award under the Company's 2002 Universal
Stock Incentive Plan, incorporated by reference to the
Company's Report on Form 8-K filed with the SEC on November
12, 2004.*
Exhibit 10.79 Form of Stock Option Agreement and Notice of Stock Option
Grant under the Company's 2002 Universal Stock Incentive
Plan, incorporated by reference to the Company's Report on
Form 8-K filed with the SEC on November 12, 2004.*
Exhibit 10.80 Form of Restricted Stock Award Agreement and Notice of
Restricted Stock Award under the Company's 2002 Universal
Stock Incentive Plan, incorporated by reference to the
Company's Report on Form 8-K filed with the SEC on November
19, 2004.*
Exhibit 10.81 Form of Restricted Stock Award Agreement and Notice of
Restricted Stock Unit Award under the Company's 2002
Universal Stock Incentive Plan, referenced in the Company's
Report on Form 8-K filed with the SEC on November 19, 2004.*
45
--------------------------------------------------------------------------------
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Exhibit 10.82 Form of Restricted Stock Award Agreement and Notice of
Restricted Stock Award under the Company's 2002 Universal
Stock Incentive Plan, incorporated by reference to Exhibit
10.1 to the Company's Form 8-K filed with the SEC on
December 21, 2004.*
Exhibit 10.83 Franklin Resources, Inc. Deferred Compensation Arrangement
for Director's Fees, date as of January 21, 2005, by and
between Franklin Resources, Inc. and Samuel H. Armacost
incorporated by reference to Exhibit 10.1 to the Company's
Form 8-K filed with the SEC on January 27, 2005.*
Exhibit 10.84 Franklin Resources, Inc. 2002 Universal Stock Incentive Plan
(as amended and restated December 16, 2004) incorporated by
reference to Exhibit 10.2 to the Company's Form 8-K filed
with the SEC on January 27, 2005.*
Exhibit 10.85 Franklin Resources, Inc. Amended and Restated Annual
Incentive Compensation Plan (as amended and restated
December 16, 2004).*
Exhibit 10.86 Description of Non-Management Director's Compensation.*
Exhibit 10.87 Description of Performance Goals for the Company's Co-Chief
Executive Officers for the 2005 Fiscal Year under the 2004
Key Executive Compensation Plan.*
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 (filed
herewith).
Exhibit 31.2 Certification of Co-Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 (filed
herewith).
Exhibit 31.3 Certification of Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002 (filed herewith).
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).
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).
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* Management/Employment Contract or Compensatory Plan or Arrangement.
CERTIFICATE OF AMENDMENT
TO THE
CERTIFICATE OF INCORPORATION
Franklin Resources, Inc. (the "Corporation"), a corporation organized and existing under and by virtue of the General Corporation Law of the State of Delaware ("DGCL"),
DOES HEREBY CERTIFY:
FIRST: That Article Fourth of the Certificate of Incorporation has been amended, so that, as amended, said Article reads in its entirety as follows:
"FOURTH: The total number of shares of stock which the corporation shall have authority to issue is One Billion One Million (1,001,000,000) shares, of which One Billion (1,000,000,000) shares shall be common stock of the par value of ten cents ($0.10), and One Million (1,000,000) shares shall be preferred stock of the par value of one dollar ($1.00). The preferred stock shall be issuable from time to time in one or more series of equal rank with such different series, designations, preferences and relative, participating, optional or other special rights, and qualifications, limitations or restrictions thereof, and shall be subject to redemption at such time or times and at such price or prices, and shall entitle the holders to receive dividends at such rates, on such conditions and at such times, and cumulative or non cumulative, and shall entitle the holders to such rates upon the dissolution of, or upon any distribution of the assets of, the corporation, and shall be convertible into, or exchangeable for, shares of any class or classes or any other series, at such price or prices or at such rate or rates of exchange and with such adjustments, as shall be stated in the resolution or resolutions providing for the issue of such stock adopted by the Board of Directors."
SECOND: That the foregoing amendment was declared advisable and was duly adopted by the Board of Directors of the Corporation and approved by a majority of the stockholders of the Corporation at the Annual Meeting of Stockholders held on January 25, 2005, in accordance with the provisions of Sections 222 and 242 of the DGCL.
IN WITNESS WHEREOF, the Corporation has caused this certificate to be issued by Martin L. Flanagan, its President and Co-Chief Executive Officer, this 2nd day of February 2005.
By: /s/ MARTIN L. FLANAGAN
--------------------------------
Martin L. Flanagan
President and Co-Chief Executive
Officer
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FRANKLIN RESOURCES, INC.
AMENDED AND RESTATED ANNUAL INCENTIVE COMPENSATION PLAN
(amended and restated December 16, 2004)
(amended and restated December 11, 2003)
I. PURPOSE
Franklin Resources, Inc. (the "Company") hereby establishes the Amended and Restated Annual Incentive Compensation Plan for Principals and Associates (as hereinafter defined) to reward the contributions to the Company made by Principals and Associates by providing them an opportunity to share in the organization's annual performance results. Through these incentives, the Company intends to attract, retain, and motivate eligible employees to achieve the highest levels of performance results in the financial services business.
II. DEFINITIONS
When used in this plan document, the following words and phrases shall have the following meanings:
2.1 "Associates' Pool" means the portion of the Award Pool allocated to Incentive Awards for Associates.
2.2 "Award Pool" means the total dollars available for funding awards under the Plan. The Award Pool is comprised of the Associates' Pool and the Principals' Pool.
2.3 "Committee" means the Compensation Committee of the Board of Directors of the Company as described in Section 9.1 below.
2.4 "Company" means Franklin Resources, Inc., a Delaware corporation, and its subsidiaries.
2.5 "Incentive Award" means the actual current value of the award to a Participant regardless of the form of the award, determined at the end of the Plan Year.
2.6 "Option" means the grant of a right to purchase Stock at a specified exercise price in recognition of and as a reward for the past efforts and contributions of the Participant on behalf of the Company and one or more of its subsidiaries, with the right to purchase such shares of Stock subject to the completion of service by the Participant, as determined by the Committee.
2.7 "Participant" means all Principals and Associates who have been determined by the Committee to be Participants, except employees who participate in commission-based incentive plans or who are non-exempt employees.
2.8 "Plan" means the Amended and Restated Annual Incentive Compensation Plan for Principals and Associates as set forth in this document, as amended from time to time.
2.9 "Pre-Tax Operating Income" (hereafter "PTOI") means the net operating income of the Company, exclusive of passive income and calculated before non-operating interest, taxes, extraordinary items and certain special items (such as special compensation payouts on account of merger) and before the accrual of Incentive Awards under the Plan and awards under the Company's 2004 Key Executive Incentive Compensation Plan or any successor plan.
2.10 "Plan Year" means the 12-month period beginning on the first day of each fiscal year of the Company, currently October 1.
2.11 "Principals' Pool" means the portion of the Award Pool allocated to Incentive Awards for Principals.
2.12 "Restricted Stock Award" means the grant of shares of Stock in recognition of and as a reward for the past efforts and contributions of the Participant on behalf of the Company and one or more of its subsidiaries, with such shares of Stock subject to a risk of forfeiture or other restrictions that will lapse based on the completion of service by the Participant, as determined by the Committee.
2.13 "Restricted Stock Unit Award" means the grant of a right to receive Stock upon the vesting of the units in recognition of and as a reward for the past efforts and contributions of the Participant on behalf of the Company and one or more of its subsidiaries, with such right to receive Stock subject to a risk of forfeiture or other restrictions that will lapse based on the completion of service by the Participant, as determined by the Committee.
2.14 "SAR" means the grant of a right to receive, in cash or Stock (as determined by the Committee), value equal to (or otherwise based on) the excess of: (a) the fair market value of a specified number of shares of Stock at the time of exercise over (b) a specified exercise price, in recognition of and as a reward for the past efforts and contributions of the Participant on behalf of the Company and one or more of its subsidiaries, with the right to receive such value in cash or Stock subject to the completion of service by the Participant, as determined by the Committee.
2.15 "Stock" means Franklin Resources, Inc. common stock reserved for issuance under the Franklin Resources, Inc. 2002 Universal Stock Incentive Plan or successor equity compensation plan.
2.16 "Stock Unit Award" means the grant of a right to receive Stock upon the vesting of the units in recognition of and as a reward for the past efforts and contributions of the Participant on behalf of the Company and one or more of its subsidiaries, with such right to receive Stock subject to a risk of forfeiture or other restrictions that will lapse based on the completion of service by the Participant, as determined by the Committee.
2.17 "Target Award" means a potential bonus opportunity for a Participant budgeted at the beginning of the Plan Year.
III. PARTICIPATION
3.1 All Principals and Associates employed by the Company at the beginning of the Plan Year are eligible to be Participants during that Plan Year. The Committee shall in its sole discretion determine annually which employees are Principals. All other eligible exempt staff are Associates. The Committee may, in its sole discretion, add exempt employees hired during a Plan Year as either Principals or Associates and may adjust Target Awards for such persons based upon such interim employment.
3.2 A non-exempt employee who becomes exempt during a Plan Year shall be eligible for an Incentive Award from the Associates' Pool, in the Committee's sole discretion.
3.3 A Participant who changes status (e.g., Associate to Principal) shall continue in his former status for that Plan Year, unless otherwise determined by the Committee.
3.4 A Participant's award will be based upon an evaluation of a Participant's overall performance, including the successful accomplishment of annual goals and objectives, as well as other performance factors. A Participant who receives a formal performance appraisal and whose overall evaluation is at less than the median level of performance relative to such Participant's peers still remains eligible for an Incentive Award, but the award may be reduced, even to zero. Participants on written warning may be eligible for an Incentive Award at the sole discretion of the Committee, but the Award may be reduced, even to zero.
IV. AWARD POOL FUNDING AND INDIVIDUAL AWARDS
4.1 For each Plan Year, the Committee shall
(a) Determine the percentage, not to exceed Twenty Percent (20%), if any, of PTOI that will be allocated to the Award Pool at various levels of Company performance measured by changes in PTOI from the prior year. The Committee may also determine if in its opinion prevailing circumstance dictates, that the Award Pool for particular identified groups of Principals and/or Associates shall be based upon the PTOI of particular identified subsidiary or subsidiaries of the Company. The determinations made by the Committee shall be subject to approval of the Board of Directors of the Company;
(b) Determine the allocation of the Award Pool of the Company and any identified subsidiary or subsidiaries of the Company as described in (a) above, between the Associates' Pool(s) and the Principal's Pool(s);
4.2 After consideration of recommendations made by management personnel, the Committee shall generally determine the amount of Target Awards for Participants under the Plan. The Committee may, in its sole discretion, advise Participants of particular Target Awards or ranges of Target Awards at any time during the Plan Year.
4.3 The actual amounts allocated to the Award Pool(s) shall be determined after the end of each Plan Year, based upon actual Company performance and PTOI.
4.4 Actual Incentive Awards are determined following the end of each Plan Year. Actual Incentive Awards will vary from the Target Awards depending on the PTOI allocated to the Award Pool and a Participant's individual performance.
4.5 The Principals' Pool will be allocated among any or all Principals on the basis of a Participant's individual performance and based upon the accomplishment of such Participant's goals and objectives for the Plan Year. No Principals are guaranteed a payout from the Principals' Pool.
4.6 The Associates' Pool will be allocated among any or all Associates on the basis of the Participant's individual performance and based upon the accomplishment of such Participant's goals and objectives for the Plan Year. No Associates are guaranteed a payout from the Associates' Pool.
4.7 To promote the highest levels of individual performance, there is no minimum or maximum which applies to individual Incentive Awards of any Participant. Amounts not allocated as awards do not carry over to the next Plan Year, and may be used for distribution as incentive compensation to employees who are not Participants in the Plan.
4.8 Notwithstanding a Participant's individual performance and anything to the contrary in this Plan, the Committee may, in its sole discretion, increase or decrease (even to zero) the Incentive Award payable to a Participant.
V. PAYMENT OF ANNUAL AWARDS
5.1 Incentive Awards may, in the Committee's discretion, be paid in the following time and manner:
(a) Incentive Awards may be paid in cash or in a combination of cash and grants of Stock, Options, SARs, Stock Unit Awards, Restricted Stock Awards and Restricted Stock Unit Awards under the 2002 Universal Stock Incentive Plan or successor equity compensation plan, and shares of investment companies in the Franklin Templeton funds, subject to restrictions and vesting determined by the Committee to be appropriate. Incentive Awards paid in Stock, Options, SARs, Stock Unit Awards, Restricted Stock Awards and Restricted Stock Unit Awards under the 2002 Universal Stock Incentive Plan or successor equity compensation plan shall also be subject to the limit on the maximum number of shares that may be issued under such plan and any additional limitations on
the maximum number of shares that may be awarded to any individual in any fiscal or calendar year under such plan.
(b) At least 25% of the Incentive Award will be paid in cash at such time after the end of the Plan Year as determined by the Committee. The balance (if any) of the cash portion of an Incentive Award shall be paid at such later time and in such manner as the Committee determines. Participants shall be notified in writing as to the date and time of payment of any such deferred portion of the Incentive Award.
(c) Stock, Options, SARs, Stock Unit Awards, Restricted Stock Awards and Restricted Stock Unit Awards awarded as part of an Incentive Award shall be distributed at such time after the end of the Plan Year as determined by the Committee. The number of shares of Stock or Units subject to such awards as well as the other terms of such awards shall be determined by the Committee in accordance with the 2002 Universal Stock Incentive Plan or successor equity compensation plan.
VI. PAYMENT IN EVENT OF DEATH, DISABILITY, LEAVE OF ABSENCE OR RETIREMENT
6.1 Death of Participant
A Participant who dies is entitled to a pro-rated Incentive Award based on
performance up to the last day worked. Payment shall be made in cash in a single
payment as soon as practical following the end of the Plan Year in which death
occurred. If the Participant dies following the end of a Plan Year but before
Incentive Awards for that year have been paid, the Participant's full Incentive
Award shall be paid in cash in a single payment when it would otherwise have
been paid. Payment of Incentive Awards on account of death shall be paid to the
person designated by the Participant as beneficiary under this Plan. If there is
no such designation or the designated beneficiary fails to survive the
Participant, payment shall be made to the Participant's spouse or if there is
none, the Participant's estate. Notwithstanding the foregoing provisions of this
Section 6.1 with respect to the payment of Incentive Awards, the Committee, in
its sole discretion, may (a) pay the Participant's full Incentive Award (or any
greater amount) or (b) decrease (even to zero) the Participant's Incentive
Award.
6.2 Disability
A Participant who ceases to be an employee on account of permanent and total disability as a result of which the Participant shall be eligible for payments under Company long term disability insurance policies, shall be entitled to receive a pro-rated Incentive Award based on performance up to the last day worked. Payment shall be made in cash in a single installment as soon as practical following the end of the fiscal year in which employment terminated. Notwithstanding the foregoing provisions of this Section 6.2 with respect to the payment of Incentive Awards, the Committee, in its sole discretion, may (a) pay the Participant's full Incentive Award (or any greater amount) or (b) decrease (even to zero) the Participant's Incentive Award.
6.3 Leave of Absence
The Committee, in its sole discretion, shall determine Incentive Awards, if any, to be paid to Participants on leave of absence for any portion of the Plan Year.
6.4 Retirement
A Participant who retires during the Plan Year is eligible to receive a
pro-rated Incentive Award based on performance to the date of retirement in cash
in a single payment as soon as practical following the end of the fiscal year in
which the Participant retires. A Participant has "retired" for purposes of this
Plan if he terminates employment with the Company after reaching age 55 with at
least 10 years of service to the Company, including service to any entity that
is acquired by the Company. Notwithstanding the foregoing provisions of this
Section 6.4 with respect to the payment of Incentive Awards, the Committee, in
its sole discretion, may (a) pay the Participant's full Incentive Award (or any
greater amount) or (b) decrease (even to zero) the Participant's Incentive
Award.
VII. PAYMENT IN EVENT OF TERMINATION OF EMPLOYMENT
7.1 Involuntary Termination of Employment
(a) If a Participant's employment is terminated by the Company as a result of the Company's dissatisfaction with the job related activities of the Participant or conviction of the Participant of a felony, the Participant shall forfeit any rights to any unpaid Incentive Awards under the Plan. Notwithstanding the foregoing, the Committee, in its sole discretion, may (i) pay the Participant a pro-rated Incentive Award based upon performance during the Plan Year to the date of termination or (ii) pay the Participant's full Incentive Award (or any greater amount).
(b) If a Participant's employment is terminated for reasons other than those described in 7.1(a) above, the Committee, in its sole discretion, may (i) pay the Participant a pro-rated Incentive Award based upon performance during the Plan Year to the date of termination or (ii) pay the Participant's full Incentive Award (or any greater amount).
7.2 Voluntary Termination of Employment
If a Participant voluntarily resigns from employment at the Company, no Incentive Awards will be paid. The Participant shall forfeit the right to any Incentive Awards for the current performance year. Notwithstanding the foregoing, the Committee, in its sole discretion, may (a) pay the Participant a pro-rated Incentive Award based upon performance during the Plan Year to the date of termination or (b) pay the Participant's full Incentive Award (or any greater amount).
VIII. AMENDMENT OR TERMINATION
8.1 Amendment.
The Committee reserves the right in its discretion to amend this Plan at any time in whole or in part, provided, however, that no amendment shall result in the forfeiture of any Participant's Incentive Awards earned as of the end of the fiscal year immediately preceding the date the Committee adopts the amendment.
8.2 Termination.
The Committee may terminate the Plan at any time. Termination shall not result in the forfeiture of any Participant's Incentive Awards which have been determined but not yet paid.
IX. ADMINISTRATION
9.1 Administration of the Plan.
This Plan shall be adopted by the shareholders of Franklin Resources, Inc. and administered by the Compensation Committee of the Board of Directors of Franklin Resources, Inc.
(a) The Committee shall meet at such times and places and upon such notice as the chairperson determines in consultation with the other Committee members. A majority of the Committee shall constitute a quorum. Any acts by the Committee may be taken at any meeting at which a quorum is present and shall be by majority vote of those members entitled to vote. Additionally, any acts reduced to writing or approved in writing by all the members of the Committee shall be valid acts of the Committee.
(b) Among the administrative responsibilities of the Committee shall be the determination of Principals and Associates, Target Awards and Incentive Awards. This may be accomplished by adopting specific methods of determining the Awards which are then administered by other management personnel of the Company.
(c) The Committee shall have the sole authority, in its absolute discretion, to adopt, amend, and rescind such rules and regulations as, in its opinion, may be advisable in the administration of the Plan, to construe and interpret the Plan, the rules and regulations, and any instruments evidencing Incentive Awards and to make all other determinations deemed necessary or advisable for the administration of the Plan. All decisions, determinations, and interpretations of the Committee shall be binding on all Participants.
(d) The Plan is intended to meet the requirements of the rules promulgated by the Securities and Exchange Commission under Section 16(b) of the Securities Exchange Act of 1934 and shall be administered and construed accordingly.
9.2 Non-alienation of Benefits.
No benefit under this Plan may be sold, assigned, transferred, conveyed, hypothecated, encumbered, anticipated, or otherwise disposed of, and any attempt to do so shall be void. No such benefit shall, prior to receipt thereof by a Participant, be in any manner subject to the debts, contracts, liabilities, engagements, or torts of such Participant.
9.3 No Limitation of Rights.
Nothing in this Plan shall be construed to limit in any way the Company's general personnel policies and procedures particularly with respect to the right of the Company to terminate a Participant's employment at any time for any reason whatsoever with or without cause; nor shall it be evidence of any agreement or understanding, express or implied, that the Company (a) will employ a Participant in any particular position, (b) will ensure participation in any incentive programs, or (c) will grant any awards for such programs.
9.4 Applicable Law.
The provisions of the Plan shall be governed by and construed in accordance with the laws of the State of California, with the exception of California's conflict of laws provisions.
9.5 Mandatory Arbitration.
As part of this Plan, the Company is implementing an alternative dispute resolution procedure for its employees. In the event there is any dispute arising out of the following: unlawful harassment; discrimination and termination of employment with the Company, which the parties are unable to resolve through direct discussion or mediation, regardless of the kind or type of dispute, the Participant and the Company agree to submit all such disputes exclusively to final and binding arbitration pursuant to the provisions of the Federal Arbitration Act, or, if inapplicable, the provisions of applicable state law, or any successor or replacement statutes, upon a request submitted in writing to the Human Resources Department within the applicable statutory limits or the statute of limitations. Any failure to timely request arbitration shall constitute a waiver of all rights to raise any claims in any forum arising out of any dispute that was subject to arbitration. The limitations period set forth in this paragraph shall not be subject to tolling, equitable or otherwise. Any agreement to arbitrate disputes contained in a securities registration application shall take precedence over this agreement. All substantive rights guaranteed under the statutes are still recognized through arbitration, and arbitration is merely a substituted forum for dispute resolutions.
This Plan was originally approved by the stockholders of the Company on January 19, 1994. The stockholders of the Company approved an amendment of the Plan on January 24, 1995. The Board approved an amendment and restatement of the Plan on December 11, 2003 to (a) provide that up to 20% of PTOI may be allocated to the Award Pool by the Committee and (b) give broad discretion to the Committee in determining the amount of Incentive Awards payable to Participants in the Plan, which amendment and restatement was approved by the stockholders of the Company on January 29, 2004. The Board approved an amendment and restatement of the Plan on December 16, 2004 to provide that Incentive Awards may be paid in Options, SARs, Stock Unit Awards and Restricted Stock Unit Awards, which amendment and restatement is not subject to the approval of the stockholders of the Company.
FRANKLIN RESOURCES, INC.
DESCRIPTION OF NON-MANAGEMENT DIRECTORS' COMPENSATION
Effective January 1, 2005, directors who are not employees of Franklin Resources, Inc. (the "Company" or "Franklin") will be paid $12,500 per quarter, plus $3,000 per meeting and will receive an annual grant of common stock of the Company valued at $75,000 (rounded up to the nearest whole share) on the date of grant on January 25, 2005 and on the date of the annual organizational meeting of the Board of Directors of the Company in subsequent fiscal years. In addition, the Company has a policy of reimbursing certain health insurance coverage for a director who is retired from other employment and is not otherwise eligible for group health coverage under Franklin's group health plan or any other company's health plan. Franklin will reimburse the cost of health insurance coverage comparable to that provided to Franklin employees. Franklin also allows directors to defer payment of their directors' fees, and to treat the deferred amounts as hypothetical investments in Franklin common stock. Upon termination, the number of shares of stock that the director hypothetically purchased are added together, and Franklin must pay the director an amount equal to the value of the hypothetical investment, including dividend reinvestment.
DESCRIPTION OF PERFORMANCE GOALS FOR CO-CHIEF EXECUTIVE OFFICERS FOR THE
2005 FISCAL YEAR UNDER THE 2004 KEY EXECUTIVE INCENTIVE COMPENSATION PLAN
On December 23, 2004, the Compensation Committee of the Board of Directors of Franklin Resources, Inc. (the "Company") established maximum individual target awards of $5,000,000 for the 2005 fiscal year for each of Mr. Martin L. Flanagan and Mr. Gregory E. Johnson under the Company's 2004 Key Executive Incentive Compensation Plan. If the Company's operating profit margin is at least 26.35% for the 2005 fiscal year, then each participant will receive $1,500,000 of the aggregate maximum individual target awards. If such operating profit margin is less than 26.35%, then each participant will forfeit any right to receive this $1,500,000 portion of the target awards. If the average percentage growth of earnings per share and pre-tax operating income for the 2005 fiscal year is 25% or greater, then each participant will receive $3,500,000 of the aggregate maximum individual target awards. If such percentage is 20% to 24%, then the award will be $2,800,000; if the percentage is 15% to 19%, then the award will be $2,100,000; if the percentage is 10% to 14%, then the award will be $1,400,000; and if the percentage is 5% to 9%, then the award will be $700,000. If such percentage is less than 5%, then each participant will forfeit any right to receive this $3,500,000 portion of the maximum target award. Notwithstanding these potential target awards, the actual awards payable to either or both of Mr. Flanagan and Mr. G. Johnson are subject to the Compensation Committee's authority to reduce the award otherwise payable to the participant. The awards are payable in cash or Company stock at the discretion of the Compensation Committee.
COMPUTATIONS OF RATIOS OF EARNINGS TO FIXED CHARGES
THREE MONTHS ENDED
DECEMBER 31,
(in thousands) 2004 2003
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Income before taxes on income and cumulative effect of an accounting change $335,649 $235,940
Add fixed charges:
Interest expense - excluding interest on deposits 8,388 7,676
Interest expense - deposits 1,408 1,142
Interest factor on rent /1 3,720 3,371
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Total fixed charges 13,516 12,189
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----------------------------------------------------------------------------------------------------
Earnings before fixed charges and taxes on income $349,165 $248,129
----------------------------------------------------------------------------------------------------
Ratio of earnings to fixed charges - including interest on deposits 25.8 20.4
Ratio of earnings to fixed charges - excluding interest on deposits 28.7 22.4
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1 Interest factor on rent represents one-third of rental expense (the approximate portion
of rental expense representing interest).
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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: February 8, 2005 /S/ MARTIN L. FLANAGAN
---------------------------
Martin L. Flanagan
President and Co-Chief Executive Officer
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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: February 8, 2005 /S/ GREGORY E. JOHNSON
---------------------------
Gregory E. Johnson
President and Co-Chief Executive Officer
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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: February 8, 2005 /S/ JAMES R. BAIO
------------------
James R. Baio
Senior Vice President and
Chief Financial Officer
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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 December 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: February 8, 2005 /S/ MARTIN L. FLANAGAN
---------------------------
Martin L. Flanagan
President and Co-Chief Executive Officer
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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 December 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: February 8, 2005 /S/ GREGORY E. JOHNSON
---------------------------
Gregory E. Johnson
President and Co-Chief Executive Officer
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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 December 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: February 8, 2005 /S/ JAMES R. BAIO
------------------
James R. Baio
Senior Vice President and
Chief Financial Officer
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