UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(MARK ONE)
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2010
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 Number: 001-09318
FRANKLIN RESOURCES, INC.
(Exact name of registrant as specified in its charter)
Delaware | 13-2670991 | |
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) |
One Franklin Parkway, San Mateo, CA | 94403 | |
(Address of principal executive offices) | (Zip Code) |
(650) 312-2000
(Registrants telephone number, including area code)
N/A
(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. x YES ¨ NO
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x YES ¨ NO
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x |
Accelerated filer ¨ | |||||
Non-accelerated filer ¨ (Do not check if a smaller reporting company) |
Smaller reporting company ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨ YES x NO
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date.
Outstanding: 225,089,900 shares of common stock, par value $0.10 per share, of Franklin Resources, Inc. as of July 31, 2010.
PART I FINANCIAL INFORMATION
Item 1. Financial Statements.
FRANKLIN RESOURCES, INC.
Condensed Consolidated Statements of Income
Unaudited
Three Months Ended June 30, |
Nine Months
Ended June 30, |
|||||||||||||||
(in thousands, except per share data) |
2010 | 2009 | 2010 | 2009 | ||||||||||||
Operating Revenues |
||||||||||||||||
Investment management fees |
$ | 915,866 | $ | 625,025 | $ | 2,558,607 | $ | 1,778,235 | ||||||||
Underwriting and distribution fees |
529,313 | 365,217 | 1,514,147 | 974,801 | ||||||||||||
Shareholder servicing fees |
72,976 | 67,113 | 213,895 | 199,969 | ||||||||||||
Consolidated sponsored investment products income, net |
1,457 | 2,908 | 2,445 | 6,555 | ||||||||||||
Other, net |
14,459 | 13,295 | 35,501 | (4,400 | ) | |||||||||||
Total operating revenues |
1,534,071 | 1,073,558 | 4,324,595 | 2,955,160 | ||||||||||||
Operating Expenses |
||||||||||||||||
Underwriting and distribution |
519,607 | 350,675 | 1,473,657 | 933,738 | ||||||||||||
Compensation and benefits |
280,333 | 230,943 | 805,686 | 711,738 | ||||||||||||
Information systems, technology and occupancy |
76,018 | 68,203 | 214,236 | 202,199 | ||||||||||||
Advertising and promotion |
37,976 | 27,888 | 110,945 | 78,815 | ||||||||||||
Amortization of deferred sales commissions |
50,121 | 32,865 | 142,949 | 103,231 | ||||||||||||
Other |
48,452 | 36,798 | 127,446 | 107,567 | ||||||||||||
Total operating expenses |
1,012,507 | 747,372 | 2,874,919 | 2,137,288 | ||||||||||||
Operating Income |
521,564 | 326,186 | 1,449,676 | 817,872 | ||||||||||||
Other Income (Expenses) |
||||||||||||||||
Consolidated sponsored investment products gains (losses), net |
(14,670 | ) | 44,503 | 6,071 | (14,045 | ) | ||||||||||
Investment and other income (losses), net |
(7,262 | ) | 52,574 | 68,204 | (26,341 | ) | ||||||||||
Interest expense |
(4,836 | ) | (211 | ) | (6,514 | ) | (3,503 | ) | ||||||||
Other income (expenses), net |
(26,768 | ) | 96,866 | 67,761 | (43,889 | ) | ||||||||||
Income before taxes |
494,796 | 423,052 | 1,517,437 | 773,983 | ||||||||||||
Taxes on income |
135,113 | 116,204 | 441,795 | 248,134 | ||||||||||||
Net Income |
$ | 359,683 | $ | 306,848 | $ | 1,075,642 | $ | 525,849 | ||||||||
Less: Net income (loss) attributable to noncontrolling interests |
(812 | ) | 9,132 | 2,859 | (3,573 | ) | ||||||||||
Net Income attributable to Franklin Resources, Inc. |
$ | 360,495 | $ | 297,716 | $ | 1,072,783 | $ | 529,422 | ||||||||
Earnings per Share |
||||||||||||||||
Basic |
$ | 1.59 | $ | 1.28 | $ | 4.70 | $ | 2.28 | ||||||||
Diluted |
1.58 | 1.28 | 4.68 | 2.27 | ||||||||||||
Dividends per Share |
$ | 0.22 | $ | 0.21 | $ | 3.66 | $ | 0.63 |
See Notes to Condensed Consolidated Financial Statements.
2
FRANKLIN RESOURCES, INC.
Condensed Consolidated Balance Sheets
Unaudited
(in thousands) |
June 30, 2010 |
September
30, 2009 | ||||
Assets |
||||||
Current Assets |
||||||
Cash and cash equivalents |
$ | 3,859,467 | $ | 2,982,539 | ||
Receivables |
680,236 | 581,810 | ||||
Investment securities, trading |
473,895 | 502,609 | ||||
Investment securities, available-for-sale |
895,394 | 1,027,287 | ||||
Other investments |
13,939 | 51,950 | ||||
Deferred taxes |
78,721 | 67,773 | ||||
Prepaid expenses and other |
25,912 | 30,452 | ||||
Total current assets |
6,027,564 | 5,244,420 | ||||
Banking/Finance Assets |
||||||
Cash and cash equivalents |
131,155 | 121,912 | ||||
Investment securities, trading |
24,551 | 110,600 | ||||
Investment securities, available-for-sale |
430,243 | 472,055 | ||||
Loans held for sale |
8,738 | 15,711 | ||||
Loans receivable, net |
371,691 | 310,504 | ||||
Other |
9,972 | 8,383 | ||||
Total banking/finance assets |
976,350 | 1,039,165 | ||||
Non-Current Assets |
||||||
Investment securities, available-for-sale |
104,121 | 108,838 | ||||
Investments in equity method investees and other |
631,605 | 398,995 | ||||
Deferred sales commissions |
89,725 | 103,993 | ||||
Property and equipment, net |
538,307 | 535,459 | ||||
Goodwill |
1,438,109 | 1,436,626 | ||||
Other intangible assets, net |
561,810 | 567,974 | ||||
Other |
42,223 | 32,993 | ||||
Total non-current assets |
3,405,900 | 3,184,878 | ||||
Total Assets |
$ | 10,409,814 | $ | 9,468,463 | ||
[Table continued on next page]
See Notes to Condensed Consolidated Financial Statements.
3
FRANKLIN RESOURCES, INC.
Condensed Consolidated Balance Sheets
Unaudited
[Table continued from previous page]
(in thousands, except share data) |
June 30, 2010 |
September
30, 2009 | ||||
Liabilities and Stockholders Equity |
||||||
Current Liabilities |
||||||
Compensation and benefits |
$ | 280,260 | $ | 210,789 | ||
Commercial paper |
0 | 64,156 | ||||
Accounts payable and accrued expenses |
342,145 | 174,525 | ||||
Commissions |
279,196 | 219,356 | ||||
Income taxes |
59,952 | 28,363 | ||||
Other |
30,769 | 28,351 | ||||
Total current liabilities |
992,322 | 725,540 | ||||
Banking/Finance Liabilities |
||||||
Deposits |
669,792 | 664,580 | ||||
Federal Home Loan Bank advances |
51,000 | 57,000 | ||||
Other |
19,748 | 24,653 | ||||
Total banking/finance liabilities |
740,540 | 746,233 | ||||
Non-Current Liabilities |
||||||
Long-term debt |
898,836 | 0 | ||||
Deferred taxes |
230,758 | 218,845 | ||||
Other |
88,652 | 78,284 | ||||
Total non-current liabilities |
1,218,246 | 297,129 | ||||
Total liabilities |
2,951,108 | 1,768,902 | ||||
Commitments and Contingencies (Note 11) |
||||||
Redeemable Noncontrolling Interests |
28,795 | 65,126 | ||||
Stockholders Equity |
||||||
Preferred stock, $1.00 par value, 1,000,000 shares authorized; none issued |
0 | 0 | ||||
Common stock, $0.10 par value, 1,000,000,000 shares authorized; 225,385,015 and 229,324,345 shares issued and outstanding, at June 30, 2010 and September 30, 2009 |
22,539 | 22,932 | ||||
Retained earnings |
7,344,705 | 7,505,890 | ||||
Accumulated other comprehensive income |
59,258 | 103,351 | ||||
Total Franklin Resources, Inc. stockholders equity |
7,426,502 | 7,632,173 | ||||
Nonredeemable noncontrolling interests |
3,409 | 2,262 | ||||
Total stockholders equity |
7,429,911 | 7,634,435 | ||||
Total Liabilities and Stockholders Equity |
$ | 10,409,814 | $ | 9,468,463 | ||
See Notes to Condensed Consolidated Financial Statements.
4
FRANKLIN RESOURCES, INC.
Condensed Consolidated Statements of Cash Flows
Unaudited
Nine Months Ended June 30, |
||||||||
(in thousands) |
2010 | 2009 | ||||||
Net Income |
$ | 1,075,642 | $ | 525,849 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: |
||||||||
Depreciation and amortization |
200,804 | 129,997 | ||||||
Stock-based compensation |
62,708 | 61,918 | ||||||
Excess tax benefits from stock-based compensation arrangements |
(11,035 | ) | (3,385 | ) | ||||
Net (gains) losses on sale of assets |
(13,887 | ) | 11,553 | |||||
Equity in net losses of affiliated companies |
20,438 | 8,608 | ||||||
Provision for loan losses |
2,722 | 5,952 | ||||||
Other-than-temporary impairment of investments |
1,463 | 59,744 | ||||||
Deferred income taxes |
(1,998 | ) | (23,720 | ) | ||||
Changes in operating assets and liabilities: |
||||||||
(Increase) decrease in receivables, prepaid expenses and other |
(115,407 | ) | 51,030 | |||||
Principal collected on loans held for sale, net |
4,052 | 15,622 | ||||||
Increase in trading securities, net |
(122,314 | ) | (170,261 | ) | ||||
Advances of deferred sales commissions |
(128,575 | ) | (60,912 | ) | ||||
Increase (decrease) in income taxes payable |
51,670 | (24,403 | ) | |||||
Increase (decrease) in commissions payable |
59,840 | (40,962 | ) | |||||
Increase in other liabilities |
176,682 | 53,132 | ||||||
Increase (decrease) in accrued compensation and benefits |
77,132 | (110,752 | ) | |||||
Net cash provided by operating activities |
1,339,937 | 489,010 | ||||||
Purchase of investments |
(586,152 | ) | (1,748,981 | ) | ||||
Liquidation of investments |
550,271 | 1,506,632 | ||||||
Purchase of banking/finance investments |
(20,000 | ) | (208,920 | ) | ||||
Liquidation of banking/finance investments |
160,481 | 44,433 | ||||||
(Increase) decrease in loans receivable |
(60,987 | ) | 64,564 | |||||
Additions of property and equipment, net |
(52,987 | ) | (32,428 | ) | ||||
Acquisitions of subsidiaries, net of cash acquired |
0 | 533 | ||||||
Net cash used in investing activities |
(9,374 | ) | (374,167 | ) | ||||
Increase in bank deposits, net |
5,212 | 76,328 | ||||||
Issuance of common stock, including stock option exercises |
28,365 | 14,722 | ||||||
Dividends paid on common stock |
(833,893 | ) | (144,270 | ) | ||||
Purchase of common stock |
(503,762 | ) | (218,677 | ) | ||||
Excess tax benefits from stock-based compensation arrangements |
11,035 | 3,385 | ||||||
Proceeds from issuance of commercial paper, net |
(64,510 | ) | (11,987 | ) | ||||
Proceeds from issuance of debt |
952,036 | 125,750 | ||||||
Payments on debt |
(66,000 | ) | (169,551 | ) | ||||
Noncontrolling interests, net |
56,897 | 69,747 | ||||||
Net cash used in financing activities |
(414,620 | ) | (254,553 | ) | ||||
Effect of exchange rate changes on cash and cash equivalents |
(29,772 | ) | (17,177 | ) | ||||
Increase (decrease) in cash and cash equivalents |
886,171 | (156,887 | ) | |||||
Cash and cash equivalents, beginning of period |
3,104,451 | 2,527,552 | ||||||
Cash and Cash Equivalents, End of Period |
$ | 3,990,622 | $ | 2,370,665 | ||||
[Table continued on next page]
See Notes to Condensed Consolidated Financial Statements.
5
FRANKLIN RESOURCES, INC.
Condensed Consolidated Statements of Cash Flows
Unaudited
[Table continued from previous page]
Nine Months Ended June 30, |
||||||||
(in thousands) |
2010 | 2009 | ||||||
Components of Cash and Cash Equivalents |
||||||||
Cash and cash equivalents, beginning of period: |
||||||||
Current assets |
$ | 2,982,539 | $ | 2,314,818 | ||||
Banking/finance assets |
121,912 | 212,734 | ||||||
Total |
$ | 3,104,451 | $ | 2,527,552 | ||||
Cash and cash equivalents, end of period: |
||||||||
Current assets |
$ | 3,859,467 | $ | 2,238,467 | ||||
Banking/finance assets |
131,155 | 132,198 | ||||||
Total |
$ | 3,990,622 | $ | 2,370,665 | ||||
Supplemental Disclosure of Non-Cash Information |
||||||||
Change in assets related to the net deconsolidation of certain sponsored investment products |
$ | (108,534 | ) | $ | (129,187 | ) | ||
Change in liabilities related to the net deconsolidation of certain sponsored investment products |
(12,308 | ) | (69,794 | ) | ||||
Supplemental Disclosure of Cash Flow Information |
||||||||
Cash paid for income taxes |
$ | 383,210 | $ | 305,730 | ||||
Cash paid for interest |
5,601 | 7,189 |
See Notes to Condensed Consolidated Financial Statements.
6
FRANKLIN RESOURCES, INC.
Notes to Condensed Consolidated Financial Statements
June 30, 2010
(Unaudited)
Note 1 - Basis of Presentation
The unaudited interim financial statements of Franklin Resources, Inc. (Franklin) and its consolidated subsidiaries (collectively, the Company) included herein have been prepared by the Company 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, some information and footnote disclosures normally included in financial statements prepared under accounting principles generally accepted in the United States of America have been shortened or omitted. Management believes that all adjustments necessary for a fair statement of the financial position and the results of operations for the periods shown have been made. All adjustments are normal and recurring. These financial statements should be read together with the Companys audited financial statements included in its Form 10-K for the fiscal year ended September 30, 2009 (fiscal year 2009). Certain amounts for the comparative prior fiscal year periods have been reclassified to conform to the financial statement presentation as of and for the period ended June 30, 2010, including those required by the retrospective adoption of new accounting guidance relating to noncontrolling interests and the computation of earnings per share (see Note 2 New Accounting Standards).
Note 2 - New Accounting Standards
Recently Adopted Accounting Standards
In the first quarter, the Company adopted a new Financial Accounting Standards Board (FASB) standard that permits a reporting entity to measure the fair value of certain alternative investments that do not have a readily determinable fair value on the basis of the investments net asset value per share or its equivalent. The adoption of the standard had no impact on the Companys consolidated financial statements.
In the first quarter, the Company adopted a new FASB standard that establishes accounting and reporting standards for noncontrolling interests in a subsidiary (previously referred to as minority interests) and for the deconsolidation of a subsidiary. The standard clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as a component of equity, separate from the parents equity, in the consolidated financial statements. In addition, it modifies the presentation of consolidated net income to include the amount attributable to noncontrolling interests. The standard requires retrospective adoption of the presentation and disclosure requirements for existing noncontrolling interests. All other requirements of the standard are applied prospectively. The adoption of the standard did not have a material effect on the Companys consolidated financial position or results of operations, but resulted in changes in financial statement presentation and disclosure for all periods presented. Minority interests have been recharacterized as redeemable noncontrolling interests and classified as temporary equity, if currently redeemable or convertible for cash or other assets at the option of the holder, or otherwise as nonredeemable noncontrolling interests and classified as a component of equity. Additionally, the presentation of consolidated net income was modified to include the amount attributable to noncontrolling interests.
In the first quarter, the Company adopted a new FASB standard that specifies that nonvested share-based payment awards containing nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. All prior period earnings per share data presented must be adjusted retrospectively. The adoption of the standard did not have a material impact on basic or diluted earnings per share.
New Accounting Standards Not Yet Adopted
In February 2010, the FASB issued an amendment to a standard relating to the consolidation of variable interest entities. For certain investments held by a reporting entity, the amendment indefinitely defers a requirement to perform a qualitative analysis to determine whether its variable interests give it a controlling financial interest in a variable interest entity (VIE). The deferral generally applies to the reporting entitys interests in entities that have the attributes of an investment company or that apply the specialized industry accounting guidance for investment companies. The amended standard is effective for fiscal years beginning after November 15, 2009.
The adoption of the amended standard on October 1, 2010 is expected to result in the consolidation of certain qualifying special purpose entities (QSPEs) and VIEs that are not currently consolidated. The consolidation of these entities, which consist of automobile loan securitization trusts and collateralized loan obligations, will result in an increase in loans receivable, net, investment securities, and long-term debt in the Companys consolidated balance sheet and the management and performance fees earned from the entities will be eliminated from its consolidated statement of income. The Company expects to initially measure the assets and liabilities of the automobile securitization trusts at their carrying values (the amounts at which they would have been carried in the
7
Companys consolidated financial statements if the Company had always consolidated the trusts). Additionally, the Company expects to elect the fair value option for the collateralized loan obligations, in which all of their financial assets and liabilities will be recorded at fair value upon adoption of the amended standard and subsequent changes in fair value will be recognized in earnings. The entities hold aggregate assets of approximately $1.4 billion as of June 30, 2010. Total assets held by the entities as of October 1, 2010 are expected to be lower due to anticipated paydowns of receivables held in the entities and scheduled maturities of debt issued by the entities.
Note 3 - Stockholders Equity and Comprehensive Income
The changes in stockholders equity and redeemable noncontrolling interests for the nine months ended June 30, 2010 and 2009 were as follows:
(in thousands) |
Franklin Resources, Inc. Stockholders Equity |
Nonredeemable Noncontrolling Interests |
Total Stockholders Equity |
Redeemable Noncontrolling Interests |
||||||||||||
Balance at October 1, 2009 |
$ | 7,632,173 | $ | 2,262 | $ | 7,634,435 | $ | 65,126 | ||||||||
Net income |
1,072,783 | 600 | 1,073,383 | 2,259 | ||||||||||||
Other comprehensive income (loss) |
||||||||||||||||
Net unrealized gains on investments, net of tax |
2,738 | 0 | 2,738 | 0 | ||||||||||||
Currency translation adjustments |
(46,568 | ) | 0 | (46,568 | ) | 0 | ||||||||||
Net unrealized losses on defined benefit plans, |
(263 | ) | 0 | (263 | ) | 0 | ||||||||||
Cash dividends on common stock |
(836,773 | ) | 0 | (836,773 | ) | 0 | ||||||||||
Repurchase of common stock |
(503,762 | ) | 0 | (503,762 | ) | 0 | ||||||||||
Other |
106,174 | 547 | 106,721 | (38,590 | ) | |||||||||||
Balance at June 30, 2010 |
$ | 7,426,502 | $ | 3,409 | $ | 7,429,911 | $ | 28,795 | ||||||||
(in thousands) |
Franklin Resources, Inc. Stockholders Equity |
Nonredeemable Noncontrolling Interests |
Total Stockholders Equity |
Redeemable Noncontrolling Interests |
||||||||||||
Balance at October 1, 2008 |
$ | 7,074,364 | $ | 29,608 | $ | 7,103,972 | $ | 47,554 | ||||||||
Net income (loss) |
529,422 | (3,597 | ) | 525,825 | 24 | |||||||||||
Other comprehensive income (loss) |
||||||||||||||||
Net unrealized gains on investments, net of tax |
55,910 | 0 | 55,910 | 0 | ||||||||||||
Currency translation adjustments |
(41,000 | ) | 0 | (41,000 | ) | 0 | ||||||||||
Net unrealized losses on defined benefit plans, |
(128 | ) | 0 | (128 | ) | 0 | ||||||||||
Cash dividends on common stock |
(146,222 | ) | 0 | (146,222 | ) | 0 | ||||||||||
Repurchase of common stock |
(218,677 | ) | 0 | (218,677 | ) | 0 | ||||||||||
Other |
89,848 | (23,567 | ) | 66,281 | 36,707 | |||||||||||
Balance at June 30, 2009 |
$ | 7,343,517 | $ | 2,444 | $ | 7,345,961 | $ | 84,285 | ||||||||
The components of comprehensive income, including amounts attributable to redeemable noncontrolling interests, were as follows:
Three Months Ended June 30, |
Nine Months
Ended June 30, |
|||||||||||||||
(in thousands) |
2010 | 2009 | 2010 | 2009 | ||||||||||||
Net income |
$ | 359,683 | $ | 306,848 | $ | 1,075,642 | $ | 525,849 | ||||||||
Net unrealized gains (losses) on investments, net of tax |
(32,416 | ) | 51,133 | 2,738 | 55,910 | |||||||||||
Currency translation adjustments |
(51,505 | ) | 78,877 | (46,568 | ) | (41,000 | ) | |||||||||
Net unrealized losses on defined benefit plans, net of tax |
(508 | ) | (45 | ) | (263 | ) | (128 | ) | ||||||||
Total Comprehensive Income |
275,254 | 436,813 | 1,031,549 | 540,631 | ||||||||||||
Less: Comprehensive income (loss) |
(812 | ) | 9,132 | 2,859 | (3,573 | ) | ||||||||||
Total Comprehensive Income attributable |
$ | 276,066 | $ | 427,681 | $ | 1,028,690 | $ | 544,204 | ||||||||
8
Note 4 - Earnings per Share
Basic earnings per share is computed by dividing net income available to the Companys common shareholders, which exclude participating securities, by the weighted average number of shares of common stock outstanding during the period. The Companys participating securities consist of its nonvested stock and stock unit awards that contain nonforfeitable rights to dividends or dividend equivalents. Diluted earnings per share is computed on the basis of the weighted-average number of shares of common stock plus the effect of dilutive potential common shares outstanding during the period using the two-class method.
The components of basic and diluted earnings per share were as follows:
Three Months Ended June 30, |
Nine Months
Ended June 30, |
|||||||||||||||
(in thousands, except per share data) |
2010 | 2009 | 2010 | 2009 | ||||||||||||
Net Income attributable to Franklin Resources, Inc. |
$ | 360,495 | $ | 297,716 | $ | 1,072,783 | $ | 529,422 | ||||||||
Less: Allocation of earnings to participating nonvested stock and stock unit awards |
2,016 | 2,438 | 5,976 | 4,062 | ||||||||||||
Net Income Available to Common Stockholders |
$ | 358,479 | $ | 295,278 | $ | 1,066,807 | $ | 525,360 | ||||||||
Weighted-average shares outstanding basic |
225,626 | 229,804 | 226,858 | 230,871 | ||||||||||||
Effect of dilutive common stock options and non-participating nonvested stock unit awards |
1,180 | 1,015 | 1,282 | 960 | ||||||||||||
Weighted-Average Shares Outstanding Diluted |
226,806 | 230,819 | 228,140 | 231,831 | ||||||||||||
Earnings per Share |
||||||||||||||||
Basic |
$ | 1.59 | $ | 1.28 | $ | 4.70 | $ | 2.28 | ||||||||
Diluted |
1.58 | 1.28 | 4.68 | 2.27 |
For the three and nine months ended June 30, 2010, the Company excluded approximately 0.4 million shares of non-participating nonvested stock unit awards from the calculation of diluted earnings per share because their effect would have been anti-dilutive. There were no anti-dilutive potential common shares outstanding during the three and nine months ended June 30, 2009.
Note 5 - Cash and Cash Equivalents
The Company discloses cash and cash equivalents as separate components of current assets and banking/finance assets in its condensed consolidated balance sheets. Cash and cash equivalents consisted of the following:
(in thousands) |
June 30, 2010 |
September
30, 2009 | ||||
Cash on hand and non-interest-bearing deposits with financial institutions |
$ | 36,597 | $ | 134,508 | ||
Interest-bearing deposits with financial institutions |
481,698 | 350,483 | ||||
Federal funds sold |
1,419 | 5,242 | ||||
Sponsored money market funds |
1,784,908 | 1,407,801 | ||||
Time deposits, securities of the U.S. Treasury and federal agencies and other |
1,686,000 | 1,206,417 | ||||
Total |
$ | 3,990,622 | $ | 3,104,451 | ||
Federal Reserve Board regulations require certain of the Companys banking subsidiaries to maintain reserve and clearing balances on deposits with the Federal Reserve Banks. The required reserve balances were $8.7 million at June 30, 2010 and $7.0 million at September 30, 2009. The required clearing balance was $1.2 million at June 30, 2010 and September 30, 2009.
The Company maintains cash and cash equivalents with financial institutions in various countries, limits the amount of credit exposure with any given financial institution and conducts ongoing evaluations of the creditworthiness of the financial institutions with which it does business.
9
Note 6 - Investments
Investments consisted of the following:
(in thousands) |
June 30, 2010 |
September
30, 2009 | ||||
Current |
||||||
Investment securities, trading |
$ | 473,895 | $ | 502,609 | ||
Investment securities, available-for-sale |
||||||
Sponsored investment products |
874,057 | 943,824 | ||||
U.S. government-sponsored enterprise obligations1 |
0 | 5,200 | ||||
Securities of U.S. states and political subdivisions |
8,947 | 15,118 | ||||
Securities of the U.S. Treasury and federal agencies |
603 | 50,616 | ||||
Other equity securities |
11,787 | 12,529 | ||||
Total investment securities, available-for-sale |
895,394 | 1,027,287 | ||||
Other investments2 |
13,939 | 51,950 | ||||
Total Current |
$ | 1,383,228 | $ | 1,581,846 | ||
Banking/Finance |
||||||
Investment securities, trading |
$ | 24,551 | $ | 110,600 | ||
Investment securities, available-for-sale |
||||||
U.S. government-sponsored enterprise obligations1 |
303,605 | 365,655 | ||||
Securities of U.S. states and political subdivisions |
841 | 852 | ||||
Securities of the U.S. Treasury and federal agencies |
3,114 | 3,566 | ||||
Corporate debt securities3 |
122,525 | 101,774 | ||||
Other equity securities |
158 | 208 | ||||
Total investment securities, available-for-sale |
430,243 | 472,055 | ||||
Total Banking/Finance |
$ | 454,794 | $ | 582,655 | ||
Non-Current |
||||||
Investment securities, available-for-sale |
||||||
Sponsored investment products |
$ | 27,364 | $ | 23,947 | ||
Securities of U.S. states and political subdivisions |
72,600 | 83,838 | ||||
Other equity securities |
4,157 | 1,053 | ||||
Total investment securities, available-for-sale |
104,121 | 108,838 | ||||
Investments in equity method investees and other |
631,605 | 398,995 | ||||
Total Non-Current |
$ | 735,726 | $ | 507,833 | ||
1 | At June 30, 2010 and September 30, 2009, U.S. government-sponsored enterprise obligations consisted of $252.4 million and $313.0 million of residential mortgage-backed securities and $51.2 million and $57.9 million of debentures. |
2 | Other investments consist of time deposits with financial institutions having original maturities greater than three months but not exceeding one year from the date of purchase. |
3 | Corporate debt securities are insured by the Federal Deposit Insurance Corporation or non-U.S. government agencies. |
At June 30, 2010 and September 30, 2009, current investment securities, trading included $223.5 million and $277.6 million of securities held by sponsored investment products that were consolidated in the Companys condensed consolidated financial statements.
At June 30, 2010 and September 30, 2009, banking/finance segment investment securities with aggregate carrying values of $213.6 million and $245.9 million were pledged as collateral for the ability to borrow from the Federal Reserve Bank, $83.2 million and $99.6 million were pledged as collateral for outstanding Federal Home Loan Bank (FHLB) borrowings and amounts available in secured FHLB short-term borrowing capacity, and $1.7 million and $1.9 million were pledged as collateral as required by federal and state regulators. In addition, investment management and related services segment securities with aggregate carrying values of $6.0 million and $5.0 million were pledged as collateral, primarily related to a credit facility for a sponsored investment product, at June 30, 2010 and September 30, 2009.
10
A summary of the gross unrealized gains and losses relating to investment securities, available-for-sale is as follows:
(in thousands)
as of June 30, 2010 |
Cost Basis | Gross Unrealized | |||||||||||
Gains | Losses | Fair Value | |||||||||||
Sponsored investment products |
$ | 821,937 | $ | 105,684 | $ | (26,200 | ) | $ | 901,421 | ||||
U.S. government-sponsored enterprise obligations |
295,808 | 7,797 | 0 | 303,605 | |||||||||
Securities of U.S. states and political subdivisions |
79,931 | 2,511 | (54 | ) | 82,388 | ||||||||
Securities of the U.S. Treasury and federal agencies |
3,714 | 6 | (3 | ) | 3,717 | ||||||||
Corporate debt securities |
120,186 | 2,350 | (11 | ) | 122,525 | ||||||||
Other equity securities |
15,655 | 457 | (10 | ) | 16,102 | ||||||||
Total |
$ | 1,337,231 | $ | 118,805 | $ | (26,278 | ) | $ | 1,429,758 | ||||
(in thousands)
as of September 30, 2009 |
Cost Basis | Gross Unrealized | |||||||||||
Gains | Losses | Fair Value | |||||||||||
Sponsored investment products |
$ | 890,745 | $ | 94,829 | $ | (17,803 | ) | $ | 967,771 | ||||
U.S. government-sponsored enterprise obligations |
366,540 | 6,566 | (2,251 | ) | 370,855 | ||||||||
Securities of U.S. states and political subdivisions |
96,647 | 3,265 | (104 | ) | 99,808 | ||||||||
Securities of the U.S. Treasury and federal agencies |
54,228 | 20 | (66 | ) | 54,182 | ||||||||
Corporate debt securities |
100,272 | 1,502 | 0 | 101,774 | |||||||||
Other equity securities |
11,136 | 2,786 | (132 | ) | 13,790 | ||||||||
Total |
$ | 1,519,568 | $ | 108,968 | $ | (20,356 | ) | $ | 1,608,180 | ||||
The net unrealized holding gains (losses) on investment securities, available-for-sale included in accumulated other comprehensive income were $(23.2) million and $15.6 million for the three and nine months ended June 30, 2010, and $52.6 million and $(6.4) million for the three and nine months ended June 30, 2009. The tax effects of the net unrealized gains (losses) included in accumulated other comprehensive income were $2.2 million and $(1.2) million for the three and nine months ended June 30, 2010, and $(3.5) million and $(9.9) million for the three and nine months ended June 30, 2009.
The following tables show the gross unrealized losses and fair values of investment securities, available-for-sale with unrealized losses aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position:
(in thousands) | Less Than 12 Months | 12 Months or Greater | Total | ||||||||||||||||||
as of June 30, 2010 |
Fair Value | Gross Unrealized Losses |
Fair Value | Gross Unrealized Losses |
Fair Value | Gross Unrealized Losses |
|||||||||||||||
Current |
|||||||||||||||||||||
Investment securities, available-for-sale |
|||||||||||||||||||||
Sponsored investment products |
$ | 80,555 | $ | (23,379 | ) | $ | 6,843 | $ | (1,506 | ) | $ | 87,398 | $ | (24,885 | ) | ||||||
Other equity securities |
6 | 0 | 27 | (4 | ) | 33 | (4 | ) | |||||||||||||
Total Current |
$ | 80,561 | $ | (23,379 | ) | $ | 6,870 | $ | (1,510 | ) | $ | 87,431 | $ | (24,889 | ) | ||||||
Banking/Finance |
|||||||||||||||||||||
Investment securities, available-for-sale |
|||||||||||||||||||||
Securities of the U.S. Treasury and federal agencies |
$ | 1,266 | $ | (3 | ) | $ | 0 | $ | 0 | $ | 1,266 | $ | (3 | ) | |||||||
Corporate debt securities |
19,989 | (11 | ) | 0 | 0 | 19,989 | (11 | ) | |||||||||||||
Total Banking/Finance |
$ | 21,255 | $ | (14 | ) | $ | 0 | $ | 0 | $ | 21,255 | $ | (14 | ) | |||||||
Non-Current |
|||||||||||||||||||||
Investment securities, available-for-sale |
|||||||||||||||||||||
Sponsored investment products |
$ | 10,535 | $ | (1,227 | ) | $ | 3,410 | $ | (88 | ) | $ | 13,945 | $ | (1,315 | ) | ||||||
Securities of U.S. states and political subdivisions |
0 | 0 | 3,169 | (54 | ) | 3,169 | (54 | ) | |||||||||||||
Other equity securities |
113 | (6 | ) | 0 | 0 | 113 | (6 | ) | |||||||||||||
Total Non-Current |
$ | 10,648 | $ | (1,233 | ) | $ | 6,579 | $ | (142 | ) | $ | 17,227 | $ | (1,375 | ) | ||||||
11
(in thousands) | Less Than 12 Months | 12 Months or Greater | Total | ||||||||||||||||||
as of September 30, 2009 |
Fair Value | Gross Unrealized Losses |
Fair Value | Gross Unrealized Losses |
Fair Value | Gross Unrealized Losses |
|||||||||||||||
Current |
|||||||||||||||||||||
Investment securities, available-for-sale |
|||||||||||||||||||||
Sponsored investment products |
$ | 89,676 | $ | (15,082 | ) | $ | 49,733 | $ | (594 | ) | $ | 139,409 | $ | (15,676 | ) | ||||||
Other equity securities |
782 | (118 | ) | 28 | (5 | ) | 810 | (123 | ) | ||||||||||||
Total Current |
$ | 90,458 | $ | (15,200 | ) | $ | 49,761 | $ | (599 | ) | $ | 140,219 | $ | (15,799 | ) | ||||||
Banking/Finance |
|||||||||||||||||||||
Investment securities, available-for-sale |
|||||||||||||||||||||
U.S. government-sponsored enterprise obligations |
$ | 53,717 | $ | (333 | ) | $ | 161,236 | $ | (1,918 | ) | $ | 214,953 | $ | (2,251 | ) | ||||||
Securities of the U.S. Treasury and federal agencies |
2,129 | (36 | ) | 1,437 | (30 | ) | 3,566 | (66 | ) | ||||||||||||
Total Banking/Finance |
$ | 55,846 | $ | (369 | ) | $ | 162,673 | $ | (1,948 | ) | $ | 218,519 | $ | (2,317 | ) | ||||||
Non-Current |
|||||||||||||||||||||
Investment securities, available-for-sale |
|||||||||||||||||||||
Sponsored investment products |
$ | 15,460 | $ | (2,038 | ) | $ | 37,653 | $ | (89 | ) | $ | 53,113 | $ | (2,127 | ) | ||||||
Securities of U.S. states and political subdivisions |
0 | 0 | 8,618 | (104 | ) | 8,618 | (104 | ) | |||||||||||||
Other equity securities |
0 | 0 | 165 | (9 | ) | 165 | (9 | ) | |||||||||||||
Total Non-Current |
$ | 15,460 | $ | (2,038 | ) | $ | 46,436 | $ | (202 | ) | $ | 61,896 | $ | (2,240 | ) | ||||||
Other-than-temporary impairment of available-for-sale investments, primarily related to sponsored investment products, was nil and $1.5 million for the three and nine months ended June 30, 2010, and $2.0 million and $59.7 million for the three and nine months ended June 30, 2009. The Company did not recognize any other-than-temporary impairment of available-for-sale debt securities during the nine months ended June 30, 2010 and 2009.
12
At June 30, 2010, maturities of available-for-sale debt securities were as follows:
(in thousands) |
Cost Basis | Fair Value | ||||
U.S. government-sponsored enterprise obligations |
||||||
Due in one year or less |
$ | 49,846 | $ | 51,212 | ||
Due after five years through ten years |
12,532 | 13,431 | ||||
Due after ten years |
233,430 | 238,962 | ||||
Total |
$ | 295,808 | $ | 303,605 | ||
Securities of U.S. states and political subdivisions |
||||||
Due in one year or less |
$ | 9,394 | $ | 9,453 | ||
Due after one year through five years |
53,977 | 56,127 | ||||
Due after five years through ten years |
13,272 | 13,572 | ||||
Due after ten years |
3,288 | 3,236 | ||||
Total |
$ | 79,931 | $ | 82,388 | ||
Securities of the U.S. Treasury and federal agencies |
||||||
Due in one year or less |
$ | 603 | $ | 603 | ||
Due after ten years |
3,111 | 3,114 | ||||
Total |
$ | 3,714 | $ | 3,717 | ||
Corporate debt securities |
||||||
Due after one year through five years |
$ | 120,186 | $ | 122,525 | ||
Total |
$ | 120,186 | $ | 122,525 | ||
Note 7 - Fair Value Measurements
The Company uses a three-level fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value based on whether the inputs to those valuation techniques are observable or unobservable. The three levels of fair value hierarchy are set forth below. The Companys assessment of the hierarchy level of the assets or liabilities measured at fair value is determined based on the lowest level input that is significant to the fair value measurement in its entirety.
Level 1 |
Unadjusted quoted prices in active markets for identical assets or liabilities. | |
Level 2 |
Observable inputs other than Level 1 quoted prices, such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or inputs other than quoted prices that are observable or corroborated by observable market data. Level 2 quoted prices are obtained from independent third-party brokers or dealers, including prices derived from model-based valuation techniques for which the significant assumptions are observable in the market or corroborated by observable market data. | |
Level 3 |
Unobservable inputs that are supported by little or no market activity. These inputs require significant management judgment and reflect the Companys estimation of assumptions that market participants would use in pricing the asset or liability. Level 3 valuations are derived primarily from model-based valuation techniques in which one or more significant inputs are unobservable in the market. |
The Company records substantially all of its investments at fair value or amounts that approximate fair value. Trading securities and securities available-for-sale are financial instruments recorded at fair value on a recurring basis. The Company recognizes transfers between levels at the end of each quarter. There were no material transfers between Level 1 and Level 2 during the nine months ended June 30, 2010.
13
The table below presents the balances of assets measured at fair value on a recurring basis.
(in thousands)
as of June 30, 2010 |
Level 1 | Level 2 | Level 3 | Total | ||||||||
Current Assets |
||||||||||||
Investment securities, trading |
$ | 330,056 | $ | 139,446 | $ | 4,393 | $ | 473,895 | ||||
Investment securities, available-for-sale |
||||||||||||
Sponsored investment products |
874,057 | 0 | 0 | 874,057 | ||||||||
Securities of U.S. states and political subdivisions |
0 | 8,947 | 0 | 8,947 | ||||||||
Securities of the U.S. Treasury and federal agencies |
0 | 603 | 0 | 603 | ||||||||
Other equity securities |
11,787 | 0 | 0 | 11,787 | ||||||||
Banking/Finance Assets |
||||||||||||
Investment securities, trading |
0 | 0 | 24,551 | 24,551 | ||||||||
Investment securities, available-for-sale |
||||||||||||
U.S. government-sponsored enterprise obligations |
0 | 303,605 | 0 | 303,605 | ||||||||
Securities of U.S. states and political subdivisions |
0 | 841 | 0 | 841 | ||||||||
Securities of the U.S. Treasury and federal agencies |
0 | 3,114 | 0 | 3,114 | ||||||||
Corporate debt securities |
0 | 122,525 | 0 | 122,525 | ||||||||
Other equity securities |
0 | 0 | 158 | 158 | ||||||||
Non-Current Assets |
||||||||||||
Investment securities, available-for-sale |
||||||||||||
Sponsored investment products |
22,193 | 0 | 5,171 | 27,364 | ||||||||
Securities of U.S. states and political subdivisions |
0 | 72,600 | 0 | 72,600 | ||||||||
Other equity securities |
136 | 4,021 | 0 | 4,157 | ||||||||
Life settlement contracts |
0 | 0 | 8,364 | 8,364 | ||||||||
Total Assets Measured at Fair Value |
$ | 1,238,229 | $ | 655,702 | $ | 42,637 | $ | 1,936,568 | ||||
(in thousands)
as of September 30, 2009 |
Level 1 | Level 2 | Level 3 | Total | ||||||||
Current Assets |
||||||||||||
Investment securities, trading |
$ | 394,754 | $ | 105,802 | $ | 2,053 | $ | 502,609 | ||||
Investment securities, available-for-sale |
||||||||||||
Sponsored investment products |
943,824 | 0 | 0 | 943,824 | ||||||||
U.S. government-sponsored enterprise obligations |
0 | 5,200 | 0 | 5,200 | ||||||||
Securities of U.S. states and political subdivisions |
0 | 15,118 | 0 | 15,118 | ||||||||
Securities of the U.S. Treasury and federal agencies |
0 | 50,616 | 0 | 50,616 | ||||||||
Other equity securities |
8,403 | 0 | 4,126 | 12,529 | ||||||||
Banking/Finance Assets |
||||||||||||
Investment securities, trading |
0 | 81,886 | 28,714 | 110,600 | ||||||||
Investment securities, available-for-sale |
||||||||||||
U.S. government-sponsored enterprise obligations |
0 | 365,655 | 0 | 365,655 | ||||||||
Securities of U.S. states and political subdivisions |
0 | 852 | 0 | 852 | ||||||||
Securities of the U.S. Treasury and federal agencies |
0 | 3,566 | 0 | 3,566 | ||||||||
Corporate debt securities |
0 | 101,774 | 0 | 101,774 | ||||||||
Other equity securities |
0 | 0 | 208 | 208 | ||||||||
Non-Current Assets |
||||||||||||
Investment securities, available-for-sale |
||||||||||||
Sponsored investment products |
19,837 | 0 | 4,110 | 23,947 | ||||||||
Securities of U.S. states and political subdivisions |
0 | 83,838 | 0 | 83,838 | ||||||||
Other equity securities |
321 | 0 | 732 | 1,053 | ||||||||
Life settlement contracts |
0 | 0 | 6,162 | 6,162 | ||||||||
Total Assets Measured at Fair Value |
$ | 1,367,139 | $ | 814,307 | $ | 46,105 | $ | 2,227,551 | ||||
14
The valuation inputs and techniques for the Companys assets measured at fair value on a recurring basis are described below.
Investment securities, trading consist primarily of securities held by consolidated sponsored investment products, non-consolidated sponsored investment products held for trading purposes and retained subordinated securities and residual interests from securitization transactions.
The fair value of securities held by consolidated sponsored investment products is primarily determined using quoted market prices or independent third-party broker or dealer price quotes. These securities are primarily classified as Level 1 or Level 2. If events occur after the close of the primary market for any security, the quoted market prices may be adjusted for the observable price movements within country specific market proxies. Consolidated sponsored investment products may also hold securities that are classified as Level 3 because their fair value is determined using unobservable inputs. In these instances, the Company primarily employs a market-based approach, which may use prices of recent transactions, various market multiples, book values and other relevant information for the investment, related assets or liabilities or other comparable assets or liabilities to determine the fair value of the investment. In developing this fair value, the Company may also give consideration to an income-based approach valuation, which considers anticipated future cash flows of the investment and converts those amounts into a net present value. A discount may also be applied due to the nature or duration of any restrictions on the disposition of the asset or liability. The fair value of non-consolidated sponsored investment products is determined based on the published net asset values of the sponsored investment products and they are classified as Level 1.
The fair value of retained subordinated securities from securitization transactions is determined using independent third-party broker or dealer price quotes and these securities are classified as Level 2. The broker or dealer price quotes are evaluated for reasonableness based upon the performance of the underlying loans and comparable transaction pricing in the securitization market. The fair value of residual interests is estimated using discounted cash flow analyses using unobservable inputs and they are classified as Level 3. Key inputs to the analysis include the excess cash flow discount rate, cumulative life loss rate, expected weighted-average life and prepayment speed assumption. The Company develops the key inputs using actual portfolio experience and recent market activity for similar transactions.
Investment securities, available-for-sale consist primarily of non-consolidated sponsored investment products and debt securities including U.S. government-sponsored enterprise obligations, securities of U.S. states and political subdivisions, securities of the U.S. Treasury and federal agencies, corporate debt securities and other equity securities. The fair value of non-consolidated sponsored investment products is determined based on the published net asset values of the sponsored investment products and they are classified as Level 1. The fair value of debt securities is determined using quoted market prices or independent third-party broker or dealer price quotes, which are evaluated for reasonableness and they are generally classified as Level 2, except for certain U.S. Treasury securities which are classified as Level 1.
The fair value of other equity securities, which consist primarily of non-sponsored investment products, is generally determined based on the published net asset values of the investment products and they are classified as Level 1. The Company may also hold other equity securities that are classified as Level 3 because their fair value is determined using unobservable inputs. In these instances the Company primarily employs the market-based approach described above for Level 3 securities held by consolidated sponsored investment products.
Life settlement contracts. The fair value of life settlement contracts is determined based on discounted cash flows using unobservable inputs and they are classified as Level 3. Inputs used to determine fair value include life expectancy assumptions and internal rates of return.
15
The changes in Level 3 assets measured at fair value on a recurring basis for the three and nine months ended June 30, 2010 and 2009 were as follows:
(in thousands) |
Securities Held by Consolidated Sponsored Investment Products |
Residual Interests from Securitization Transactions |
Other1 | Total | ||||||||||||
Balance at April 1, 2010 |
$ | 2,770 | $ | 31,504 | $ | 17,876 | $ | 52,150 | ||||||||
Total realized and unrealized gains (losses): |
||||||||||||||||
Included in other, net revenue |
0 | 3,144 | 0 | 3,144 | ||||||||||||
Included in consolidated sponsored investment products gains (losses), net |
5 | 0 | 0 | 5 | ||||||||||||
Included in investments and other income (losses), net |
0 | 0 | 646 | 646 | ||||||||||||
Included in accumulated other comprehensive income |
0 | 0 | (239 | ) | (239 | ) | ||||||||||
Purchases, sales and settlements, net |
1,624 | (10,097 | ) | (4,590 | ) | (13,063 | ) | |||||||||
Transfers out of Level 3 |
(6 | ) | 0 | 0 | (6 | ) | ||||||||||
Balance at June 30, 2010 |
$ | 4,393 | $ | 24,551 | $ | 13,693 | $ | 42,637 | ||||||||
Change in unrealized gains included in net income relating to assets still held at June 30, 2010 |
$ | 5 | 2 | $ | 3,144 | 3 | $ | 265 | $ | 3,414 | ||||||
(in thousands) |
Securities Held by Consolidated Sponsored Investment Products |
Residual Interests from Securitization Transactions |
Other1 | Total | ||||||||||||
Balance at October 1, 2009 |
$ | 2,053 | $ | 28,714 | $ | 15,338 | $ | 46,105 | ||||||||
Total realized and unrealized gains (losses): |
||||||||||||||||
Included in other, net revenue |
0 | 2,743 | 0 | 2,743 | ||||||||||||
Included in consolidated sponsored investment products gains (losses), net |
(269 | ) | 0 | 0 | (269 | ) | ||||||||||
Included in investments and other income (losses), net |
0 | 0 | 2,018 | 2,018 | ||||||||||||
Included in accumulated other comprehensive income |
0 | 0 | 652 | 652 | ||||||||||||
Purchases, sales and settlements, net |
2,615 | (6,906 | ) | (4,315 | ) | (8,606 | ) | |||||||||
Transfers out of Level 3 |
(6 | ) | 0 | 0 | (6 | ) | ||||||||||
Balance at June 30, 2010 |
$ | 4,393 | $ | 24,551 | $ | 13,693 | $ | 42,637 | ||||||||
Change in unrealized gains (losses) included in net income relating to assets still held at June 30, 2010 |
$ | (193 | )2 | $ | 2,743 | 3 | $ | 1,221 | $ | 3,771 | ||||||
(in thousands) |
Securities Held by Consolidated Sponsored Investment Products |
Residual Interests from Securitization Transactions |
Other1 | Total | ||||||||||||
Balance at April 1, 2009 |
$ | 3,102 | $ | 26,312 | $ | 12,253 | $ | 41,667 | ||||||||
Total realized and unrealized gains (losses): |
||||||||||||||||
Included in other, net revenue |
0 | (846 | ) | 0 | (846 | ) | ||||||||||
Included in consolidated sponsored investment products gains (losses), net |
536 | 0 | 0 | 536 | ||||||||||||
Included in accumulated other comprehensive income |
0 | 0 | 389 | 389 | ||||||||||||
Purchases, sales and settlements, net |
(491 | ) | 3,088 | 1,501 | 4,098 | |||||||||||
Transfers out of Level 3 |
(1,157 | ) | 0 | (702 | ) | (1,859 | ) | |||||||||
Balance at June 30, 2009 |
$ | 1,990 | $ | 28,554 | $ | 13,441 | $ | 43,985 | ||||||||
Change in unrealized gains (losses) included in net income relating to assets still held at June 30, 2009 |
$ | 392 | 2 | $ | (846 | )3 | $ | 0 | $ | (454 | ) | |||||
16
(in thousands) |
Securities Held by Consolidated Sponsored Investment Products |
Residual Interests from Securitization Transactions |
Other1 | Total | ||||||||||||
Balance at October 1, 2008 |
$ | 4,089 | $ | 29,782 | $ | 12,112 | $ | 45,983 | ||||||||
Total realized and unrealized gains (losses): |
||||||||||||||||
Included in other, net revenue |
0 | (44,511 | ) | 0 | (44,511 | ) | ||||||||||
Included in consolidated sponsored investment products gains (losses), net |
(541 | ) | 0 | 0 | (541 | ) | ||||||||||
Included in investments and other income (losses), net |
0 | 0 | (2,073 | ) | (2,073 | ) | ||||||||||
Included in accumulated other comprehensive income |
0 | 0 | 34 | 34 | ||||||||||||
Purchases, sales and settlements, net |
(522 | ) | 43,283 | 2,096 | 44,857 | |||||||||||
Transfers into (out of) Level 3 |
(1,036 | ) | 0 | 1,272 | 236 | |||||||||||
Balance at June 30, 2009 |
$ | 1,990 | $ | 28,554 | $ | 13,441 | $ | 43,985 | ||||||||
Change in unrealized losses included in net income relating to assets still held at June 30, 2009 |
$ | (688 | )2 | $ | (44,511 | )3 | $ | 0 | $ | (45,199 | ) | |||||
1 | Other primarily consists of equity securities and life settlement contracts. |
2 | Included in consolidated sponsored investment products gains (losses), net. |
3 | Included in other, net revenue. |
The Company may also measure certain assets or liabilities at fair value on a nonrecurring basis. These fair value measurements generally result from the application of lower of cost or fair value accounting for loans held for sale or write-downs of individual assets.
The Companys financial instruments that were not measured at fair value were as follows:
(in thousands) |
June 30, 2010 | September 30, 2009 | ||||||||||||
Carrying Value |
Estimated Fair Value |
Carrying Value |
Estimated Fair Value | |||||||||||
Financial Assets |
||||||||||||||
Cash and cash equivalents |
$ | 3,990,622 | $ | 3,990,622 | $ | 3,104,451 | $ | 3,104,451 | ||||||
Other investments |
13,939 | 13,939 | 51,950 | 51,950 | ||||||||||
Loans held for sale |
8,738 | 9,652 | 15,711 | 16,621 | ||||||||||
Loans receivable, net |
371,691 | 378,141 | 310,504 | 323,672 | ||||||||||
Financial Liabilities |
||||||||||||||
Commercial paper |
$ | 0 | $ | 0 | $ | 64,156 | $ | 64,156 | ||||||
Deposits |
669,792 | 673,516 | 664,580 | 667,793 | ||||||||||
FHLB advances |
51,000 | 52,016 | 57,000 | 57,026 | ||||||||||
Long-term debt |
898,836 | 929,262 | 0 | 0 |
The valuation inputs and techniques for these financial instruments are described below.
Cash and cash equivalents. Due to the short-term nature and liquidity of these financial instruments, the carrying values of cash and cash equivalents approximate fair value.
Other investments consist of time deposits with financial institutions having maturities greater than three months but less than one year from the date of purchase. Due to the short-term nature and liquidity of these financial instruments, the carrying values of these assets approximate fair value.
Loans held for sale. The fair value of automobile loans held for sale generally is estimated based on the whole loan market price that would be received if the loans were sold in their current condition, which may include adjustments based on the composition of the loan portfolio and liquidity factors. In the event of illiquid markets the fair value is determined using discounted cash flow analyses with estimated discount rates for loans with similar terms and collateral.
Loans receivable, net. The fair value of loans receivable is estimated using discounted cash flow models with interest rates that consider the current credit and interest rate risks inherent in the loans and the current economic and lending conditions. For
17
certain loans with no significant credit concerns and frequent repricing, estimated fair values are generally based on the carrying value.
Commercial paper. Due to the short-term nature and liquidity of these financial instruments, the carrying values of these liabilities approximate fair value.
Deposits. The fair value of deposits with no stated maturities is considered to approximate their carrying value because they are payable on demand. The fair value of deposits with stated maturities is estimated based on discounted cash flow models using interest rates offered by comparable institutions on deposits with similar remaining maturities.
FHLB advances. The fair value is estimated using discounted cash flow models using rates available to the Company for FHLB advances with similar terms and remaining maturities.
Long-term debt. The fair value of the long-term debt is determined using quoted market prices or independent third-party broker or dealer price quotes. The fair value may also be determined using prices of publicly traded debt with similar maturities, credit risk and interest rates.
Note 8 - Securitization of Loans Held for Sale
From time to time, the Company enters into automobile loan securitization transactions with securitization trusts structured as qualified special purpose entities (the securitization trusts), which then issue asset-backed securities to private investors. The Company records these transactions as sales. The securitization transactions are comprised of prime, non-prime and sub-prime contracts for retail installment sales that are secured by new and used automobiles purchased from motor vehicle dealers. The Company purchases the sale contracts in the ordinary course of business.
When the Company sells automobile loans in a securitization transaction, it retains certain interests. Residual interests, which include interest-only strips receivable and cash on deposit, represent the Companys contractual right to receive excess interest and cash from the pool of securitized loans after the payment of required amounts to holders of the asset-backed securities and certain other costs associated with the securitization. The residual interests are generally fully realizable and subject to limited recourse provisions. Credit enhancements for the securitization trusts require the Company to maintain a certain amount of cash on deposit, which provides protection for the holders of the asset-backed securities against delays in payment and certain losses on the securitized loans. At June 30, 2010 and September 30, 2009, the amounts of cash on deposit were $31.6 million and $46.9 million. Discounted values of the cash on deposit were recognized as part of the residual interests. The Company may also retain subordinated securities from securitization transactions, which are senior to the residual interests. The retained interests in securitized assets, including the residual interests and the retained subordinated securities, are recognized as banking/finance trading securities in the condensed consolidated balance sheets. Changes in the fair value of the retained interests are recognized in earnings.
The Company did not enter into any automobile loan securitization transactions during the nine months ended June 30, 2010 or fiscal year 2009. The securitization transactions which the Company entered into through September 30, 2008 were similar in all material respects. As a result of a securitization transaction that the Company entered into in June 2008, it retained subordinated securities in addition to the residual interests. The retained subordinated securities were sold in fiscal year 2010.
The Company determines the fair value of the retained interests in securitized assets at the end of each period (see Note 7 Fair Value Measurements for a description of fair value methodologies used).
18
The following table shows the sensitivity of the retained interests to hypothetical adverse changes in the key economic assumptions used to measure fair value:
(dollar amounts in thousands) |
June 30, 2010 |
September 30, 2009 |
||||||
Fair value of retained interests |
||||||||
Retained subordinated securities |
$ | 0 | $ | 81,886 | ||||
Residual interests |
24,551 | 28,714 | ||||||
Total |
$ | 24,551 | $ | 110,600 | ||||
Excess cash flow discount rate (annual rate) |
8.0 | % | 12.2%-14.4 | % | ||||
Impact on fair value of 10% adverse change |
$ | (321 | ) | $ | (4,133 | ) | ||
Impact on fair value of 20% adverse change |
(636 | ) | (8,225 | ) | ||||
Cumulative life loss rate |
7.3 | % | 7.4 | % | ||||
Impact on fair value of 10% adverse change |
$ | (2,031 | ) | $ | (2,376 | ) | ||
Impact on fair value of 20% adverse change |
(4,059 | ) | (4,763 | ) | ||||
Expected weighted-average life (years) |
1.6 | 2.2 | ||||||
Prepayment speed (average monthly rate) |
1.2 | % | 1.2 | % | ||||
Impact on fair value of 10% adverse change |
$ | (2,092 | ) | $ | (2,737 | ) | ||
Impact on fair value of 20% adverse change |
(3,419 | ) | (5,241 | ) |
Actual future market conditions may differ materially. Accordingly, this sensitivity analysis should not be considered the Companys projection of future events or losses.
The Company retains servicing responsibilities for automobile loan securitizations and receives annual servicing fees ranging from 1% to 2% of the loans securitized for services that it provides to the securitization trusts. The servicing fees are recognized in other, net revenue in the condensed consolidated statements of income. The Company does not recognize a servicing asset or liability because the benefits of servicing are just adequate to compensate for its servicing responsibilities as the servicing fees are consistent with current market rates that would be charged to compensate a substitute servicer for providing these services.
The following table provides a summary of cash flows received from and paid to securitization trusts.
Three Months Ended June 30, |
Nine Months
Ended June 30, |
||||||||||||||
(in thousands) |
2010 | 2009 | 2010 | 2009 | |||||||||||
Servicing fees received |
$ | 2,089 | $ | 3,118 | $ | 7,133 | $ | 10,538 | |||||||
Cash flows received related to retained subordinated securities |
0 | 1,698 | 1,933 | 5,093 | |||||||||||
Cash flows received related to residual interests |
10,859 | 0 | 10,859 | 1,554 | |||||||||||
Cash paid related to residual interests |
0 | (1,469 | ) | (1,286 | ) | (39,677 | ) |
Amounts payable to the trustee related to loan principal and interest collected on behalf of the securitization trusts of $21.0 million at June 30, 2010 and $24.1 million at September 30, 2009 were included in other banking/finance liabilities in the condensed consolidated balance sheets.
The Company provides guarantees to cover shortfalls for the securitization trusts in amounts due to the holders of the asset-backed securities if the shortfall exceeds cash on deposit. At June 30, 2010 and September 30, 2009, the maximum potential amounts of future payments related to these guarantees were $6.2 million and $7.4 million. The fair value of the guarantees was recognized as banking/finance liabilities in the condensed consolidated balance sheets and was not significant.
During the nine months ended June 30, 2010 and 2009, the Company did not provide any financial or other support to the securitization trusts or the holders of the asset-backed securities, other than as described above.
The original amount of loans serviced for the securitization trusts that were still in existence at June 30, 2010 and September 30, 2009 totaled $1.8 billion. At June 30, 2010 and September 30, 2009, the securitization trusts had 34,671 and 44,221 loans outstanding, and their weighted-average annualized interest rate was 10.5% as of the end of each period. Net charge-offs on the securitized loans held by the securitization trusts and the loans that were managed together with them were $4.3 million and $20.2 million for the three and nine months ended June 30, 2010, and $10.1 million and $36.5 million for the three and nine months ended June 30, 2009.
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The following table shows further details of the loans serviced by the Company that were held by the securitization trusts and the loans that were managed together with them:
(dollar amounts in thousands) |
June 30, 2010 |
September 30, 2009 |
||||||
Principal amount of loans |
||||||||
Securitized loans |
$ | 371,038 | $ | 551,369 | ||||
Loans held for sale |
9,300 | 16,274 | ||||||
Loans receivable |
72,971 | 85,520 | ||||||
Total |
$ | 453,309 | $ | 653,163 | ||||
Principal amount of loans 30 days or more past due1 |
$ | 14,458 | $ | 29,238 | ||||
Credit quality as a percentage of aggregate outstanding principal balance |
||||||||
Prime |
46.5 | % | 47.4 | % | ||||
Non-prime |
48.6 | % | 49.4 | % | ||||
Sub-prime |
4.9 | % | 3.2 | % |
1 | The majority of the balances were related to securitized loans. |
Note 9 - Goodwill and Other Intangible Assets
Goodwill and other intangible assets have been assigned to one reporting unit, the investment management and related services segment. The changes in the carrying values of goodwill and gross intangible assets were as follows:
(in thousands) |
Goodwill | Amortized Intangible Assets |
Non-amortized
Intangible Assets | ||||||
Balance at October 1, 2009 |
$ | 1,436,626 | $ | 200,952 | $ | 507,737 | |||
Foreign currency movements |
1,483 | 36 | 1,633 | ||||||
Balance at June 30, 2010 |
$ | 1,438,109 | $ | 200,988 | $ | 509,370 | |||
Certain of the goodwill and intangible assets are denominated in currencies other than the U.S. dollar; therefore, their gross and net carrying values are subject to foreign currency movements.
Intangible assets were as follows:
(in thousands)
as of June 30, 2010 |
Gross Carrying Value |
Accumulated |
Net Carrying Value | |||||||
Amortized intangible assets |
||||||||||
Customer base |
$ | 165,952 | $ | (115,671 | ) | $ | 50,281 | |||
Other |
35,036 | (32,877 | ) | 2,159 | ||||||
200,988 | (148,548 | ) | 52,440 | |||||||
Non-amortized intangible assets |
||||||||||
Management contracts |
509,370 | 0 | 509,370 | |||||||
Total |
$ | 710,358 | $ | (148,548 | ) | $ | 561,810 | |||
(in thousands) | ||||||||||
as of September 30, 2009 |
Gross Carrying Value |
Accumulated |
Net Carrying Value | |||||||
Amortized intangible assets |
||||||||||
Customer base |
$ | 165,915 | $ | (109,059 | ) | $ | 56,856 | |||
Other |
35,037 | (31,656 | ) | 3,381 | ||||||
200,952 | (140,715 | ) | 60,237 | |||||||
Non-amortized intangible assets |
||||||||||
Management contracts |
507,737 | 0 | 507,737 | |||||||
Total |
$ | 708,689 | $ | (140,715 | ) | $ | 567,974 | |||
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The Company completed its most recent annual impairment tests of goodwill and indefinite-lived intangible assets during the quarter ended September 30, 2009, and determined that there was no impairment in the value of these assets as of August 1, 2009. During the quarter ended June 30, 2010 an indication of potential impairment occurred for approximately 11% of the indefinite-lived intangible assets. The Company performed an updated impairment test and determined that there was no impairment as the discounted future cash flow projections exceeded the carrying value of these assets. No impairment loss in the value of goodwill and indefinite-lived intangible assets was recognized during the nine months ended June 30, 2010 and 2009.
No impairment loss in the value of intangible assets subject to amortization was recognized during the nine months ended June 30, 2010 and 2009 as the estimates of the undiscounted expected cash flows from these assets or their fair values exceeded the asset carrying values.
Amortization expense related to definite-lived intangible assets was $2.6 million for the three months ended June 30, 2010 and 2009, and $7.8 million for the nine months ended June 30, 2010 and 2009. The estimated remaining amortization expense related to definite-lived intangible assets as of June 30, 2010 was as follows:
(in thousands)
For the fiscal years ending September 30, |
Amount | ||
2010 (remaining three months) |
$ | 2,603 | |
2011 |
10,376 | ||
2012 |
8,906 | ||
2013 |
8,783 | ||
2014 |
8,783 | ||
Thereafter |
12,989 | ||
Total |
$ | 52,440 | |
Note 10 - Debt
Outstanding debt consisted of the following:
(in thousands) |
June 30, 2010 |
Effective Interest Rate |
September 30, 2009 |
Effective Interest Rate | ||||||
Current |
||||||||||
Commercial paper |
$ | 0 | N/A | $ | 64,156 | 0.27% | ||||
Banking/Finance |
||||||||||
FHLB advances |
51,000 | 3.64% | 57,000 | 2.94% | ||||||
Non-Current |
||||||||||
$300 million 2.000% notes due 2013 |
299,489 | 2.28% | 0 | N/A | ||||||
$250 million 3.125% notes due 2015 |
249,731 | 3.32% | 0 | N/A | ||||||
$350 million 4.625% notes due 2020 |
349,616 | 4.75% | 0 | N/A | ||||||
Total Long-term debt |
898,836 | 0 | ||||||||
Total Debt |
$ | 949,836 | $ | 121,156 | ||||||
At June 30, 2010, maturities for the FHLB advances and long-term debt were as follows:
(in thousands)
For the fiscal years ending September 30, |
Amount | ||
2010 (remaining three months) |
$ | 0 | |
2011 |
2,000 | ||
2012 |
0 | ||
2013 |
317,989 | ||
2014 |
0 | ||
Thereafter |
629,847 | ||
Total |
$ | 949,836 | |
21
The banking/finance segment secures advances from the FHLB to fund its retail banking and consumer lending services. At June 30, 2010, the Company had $51.0 million of FHLB advances outstanding, which are subject to collateralization requirements.
In May 2010, the Company completed the issuance of senior unsecured and unsubordinated notes with a face value of $900.0 million. The net proceeds from the issuance of the notes are available for general corporate purposes; a portion of the proceeds has been used for the repayment of previously issued commercial paper. Of these notes, $300.0 million was issued at a fixed interest rate of 2.000% per annum and matures in 2013, $250.0 million was issued at a fixed interest rate of 3.125% per annum and matures in 2015 and $350.0 million was issued at a fixed interest rate of 4.625% and matures in 2020. Interest is payable semi-annually. The notes were issued collectively at a discount of $1.2 million that is being amortized over the term of the notes. The Company incurred approximately $6.4 million in debt issuance costs, which are included in other non-current assets in the condensed consolidated balance sheet and are being amortized over the term of the notes. The notes contain an optional redemption feature that allows the Company to redeem each series of notes prior to maturity in whole or in part at any time, at a make-whole redemption price. The indenture governing the notes contains limitations on the Companys ability and the ability of its subsidiaries to pledge voting stock or profit participating equity interests in its subsidiaries to secure other debt without similarly securing the notes equally and ratably. The indenture also includes requirements that must be met if the Company consolidates or merges with, or sells all or substantially all of its assets to, another entity. As of June 30, 2010, the Company was in compliance with the covenants of the notes.
In addition, at June 30, 2010, the Company had $500.0 million of short-term commercial paper available for issuance under an uncommitted private placement program, and $14.1 million available in uncommitted short-term bank lines of credit. The Companys banking/finance segment had $295.0 million available in uncommitted short-term bank lines of credit under the Federal Reserve system, $209.1 million available through the secured Federal Reserve Bank short-term discount window and $56.3 million available in secured FHLB short-term borrowing capacity. On June 9, 2010, the Companys $420.0 million five-year revolving credit facility expired with no borrowings outstanding.
At June 30, 2010 and September 30, 2009, loans receivable with aggregate carrying values of $39.0 million and $30.6 million were pledged as collateral for the ability to obtain FHLB advances.
Note 11 - Commitments and Contingencies
Guarantees
The Company is obligated to cover shortfalls for the automobile loan securitization trusts in amounts due to the holders of the asset-backed securities up to certain levels (see Note 8 Securitization of Loans Held for Sale).
At June 30, 2010, the banking/finance segment had issued financial standby letters of credit totaling $6.3 million which beneficiaries would be able to draw upon in the event of non-performance by its customers, primarily in relation to lease and lien obligations of these banking customers. These standby letters of credit were secured by marketable securities with a fair value of $9.8 million as of June 30, 2010.
Legal Proceedings
As previously reported, between 2003 and 2006, following industry-wide market timing and late trading investigations by U.S. and Canadian regulators, and U.S. state government offices, Franklin and certain related parties were named in civil lawsuits in the U.S. and one of Franklins adviser subsidiaries was named in civil lawsuits in Canada.
In the U.S., the lawsuits were filed against Franklin and certain of its adviser and distributor affiliates, individual Franklin officers and directors, a former Franklin employee, and trustees of certain Franklin Templeton Investments mutual funds (the Funds). In 2004, the lawsuits were consolidated for coordinated proceedings with similar lawsuits against numerous other mutual fund complexes in a multi-district litigation titled In re Mutual Funds Investment Litigation, pending in the U.S. District Court for the District of Maryland, Case No. 04-md-15862 (the MDL). Plaintiffs filed consolidated amended complaints in the MDL on September 29, 2004. The three consolidated lawsuits involving the Company include a class action (Sharkey IRO/IRA v. Franklin Resources, Inc., et al., Case No. 04-cv-01310), a derivative action on behalf of the Funds (McAlvey v. Franklin Resources, Inc., et al., Case No. 04-cv-01274), and a derivative action on behalf of Franklin (Hertz v. Burns, et al., Case No. 04-cv-01624) and seek, among other forms of relief, one or more of the following: unspecified monetary damages; punitive damages; removal of Fund trustees, directors, advisers, administrators, and distributors; rescission of management contracts and distribution plans under Rule 12b-1 promulgated under the Investment Company Act of 1940; and attorneys fees and costs.
On February 25, 2005, the Company-related defendants filed motions to dismiss the consolidated amended class action and Fund derivative action complaints. On June 26, 2008, the court issued its order granting in part and denying in part the Companys motion to dismiss the consolidated amended class action complaint. In its order, the court dismissed certain claims, while allowing others under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and under Sections 36(b) and 48(a) of the Investment Company Act of 1940 to remain, and dismissed all class action claims against the named Funds. Pursuant to stipulation, the court
22
also dismissed all claims against certain individual defendants, including the independent trustees to the named Funds, and a former Franklin executive. On September 4, 2009, the court entered as its order the parties stipulation to dismiss without prejudice the remaining Fund trustee defendants named in the consolidated amended class action complaint. On January 12, 2010, lead plaintiff in the consolidated class action filed a second consolidated amended class action complaint. The Company-related defendants filed a motion for partial summary judgment in the consolidated class action on March 24, 2010, and lead plaintiff filed its opposition and cross-motion for partial summary judgment on June 4, 2010. All briefing on the motions is expected to be completed by late August 2010. The Company-related defendants motion to dismiss the consolidated fund derivative action remains under submission with the court. In addition, pursuant to stipulation, the derivative action brought on behalf of Franklin has been stayed since 2004.
In Canada, Franklin Templeton Investments Corp., a Franklin subsidiary and the manager of Franklin Templeton Investments Canadian mutual funds, is named (along with several other non-Franklin affiliated manager defendants) in two market timing lawsuits that are styled as class actions (Huneault v. AGF Funds, Inc., et al., Case No. 500-06-000256-046, filed in the Superior Court for the Province of Quebec, District of Montreal on October 25, 2004, and Fischer v. IG Investment Management Ltd., et al., Case No. 06-CV-307599CP, filed in the Ontario Superior Court of Justice on March 9, 2006). The lawsuits seek, among other forms of relief, one or more of the following: unspecified monetary damages, punitive damages, an order barring any increase in management fees for a period of two years following judgment, and attorneys fees and costs. Oral argument on petitioners motion for authorization to institute a class action in the Huneault lawsuit concluded on May 5, 2009, and the matter has remained under submission with the court since then. Separately, on January 12, 2010, the court in the Fischer lawsuit denied plaintiffs motion for class certification, and plaintiffs filed a notice of appeal of that ruling on February 22, 2010. On July 20, 2010, the parties reached an agreement-in-principle to resolve both the Huneault and Fischer actions for a total proposed payment of approximately $5.0 million subject to certain conditions including certification of a class in each lawsuit on consent for settlement purposes and court approval of the settlement.
In addition, Franklin/Templeton Distributors, Inc. (one of Franklins subsidiaries and the principal underwriter to the Funds), as well as the individual trustees to the Franklin Custodian Funds (the Trust), have been named in a lawsuit brought derivatively on behalf of the Trust, concerning payment of asset-based compensation between July 22, 2005 and the present to broker-dealers that hold Fund shares in brokerage accounts and that are not registered as investment advisers. The lawsuit is captioned Smith v. Franklin/Templeton Distributors, Inc., et al., Case No. CV 09-4775, and was filed in the U.S. District Court for the Northern District of California on October 6, 2009. Specifically, plaintiff is attempting to allege claims under Section 47(b) of the Investment Company Act of 1940, and for breach of fiduciary duty, breach of contract, and waste of Trust assets, and is seeking unspecified monetary damages, declaratory and injunctive relief enjoining further asset-based compensation to such broker-dealers, and attorneys fees and costs. Defendants filed a motion to dismiss the complaint on January 22, 2010. On June 8, 2010, the court granted defendants motion to dismiss the Section 47(b) claim (the lone federal claim), giving plaintiff limited leave to amend his complaint to cure the deficiency in that claim. Plaintiff filed an amended complaint on July 7, 2010, and, pursuant to stipulation, defendants have until August 20, 2010 to respond to the amended complaint.
Management strongly believes that the claims made in each of the unresolved lawsuits identified above are without merit and the Company intends to defend against them vigorously. The Company cannot predict with certainty, however, the eventual outcome of those lawsuits, nor whether they will have a material negative impact on the Company.
The Company is from time to time involved in litigation relating to claims arising in the normal course of business. Management is of the opinion that the ultimate resolution of such claims will not materially affect the Companys business, financial position or results of operations. In managements opinion, an adequate accrual has been made as of June 30, 2010, to provide for any probable losses that may arise from these matters for which the Company could reasonably estimate an amount.
Variable Interest Entities
The Companys variable interest entities (VIEs) primarily include certain sponsored investment products and certain other investment products (collectively, investment products). The Companys variable interests generally include its equity ownership interest in the investment products and its investment management and related services fees earned from sponsored investment products. Based on its evaluations, the Company believes it was not the primary beneficiary of its VIEs and, as a result, did not consolidate these entities as of and for the periods ended June 30, 2010 and 2009.
Total assets under management of investment products in which the Company held a variable interest, but was not the primary beneficiary, were approximately $38.8 billion at June 30, 2010 and $35.8 billion at September 30, 2009. The carrying values of the Companys equity ownership interest in and investment management and related service fees receivable from these investment products as recorded in the Companys consolidated balance sheets at June 30, 2010 and September 30, 2009 are set forth below. These amounts represent the Companys maximum exposure to loss and do not reflect an estimate of the actual losses.
23
(in thousands) |
June 30, 2010 |
September 30, 2009 | ||||
Current Assets |
||||||
Receivables |
$ | 71,497 | $ | 50,088 | ||
Investment securities, available-for-sale |
107,679 | 112,853 | ||||
Total Current |
179,176 | 162,941 | ||||
Non-Current Assets |
||||||
Investment securities, available-for-sale |
23,604 | 20,208 | ||||
Investments in equity method investees and other |
570,412 | 305,024 | ||||
Total Non-Current |
594,016 | 325,232 | ||||
Total |
$ | 773,192 | $ | 488,173 | ||
While the Company has no contractual obligation to do so, it routinely makes cash investments in the course of launching sponsored investment products. The Company also may voluntarily elect to provide its sponsored investment products with additional direct or indirect financial support based on its business objectives.
The Companys other VIEs include limited liability partnerships, limited liability companies, and joint ventures. The Companys variable interest generally comprises its equity ownership interest. These investments are recognized as investments in equity method investees because the Company is not the primary beneficiary. The investment carrying values in the Companys consolidated balance sheets related to these VIEs were $4.1 million at June 30, 2010 and $14.9 million at September 30, 2009. These amounts represent the Companys maximum exposure to loss. The Company did not provide financial or other support to its other VIEs during the nine months ended June 30, 2010 and 2009.
The joint venture VIEs previously included Lightning Finance Company Limited (LFL) and Lightning Asset Finance Limited (LAFL), in which the Company held 49% ownership interests at September 30, 2009. The Company liquidated its ownership interests in LFL and LAFL during the three months ended December 31, 2009.
Other Commitments and Contingencies
At June 30, 2010, the banking/finance segment had commitments to extend credit in an aggregate amount of $173.8 million, primarily under credit card lines.
The Company in its role as agent or trustee facilitates the settlement of investor share purchase, redemption, and other transactions with affiliated mutual funds. The Company is appointed by the affiliated mutual funds as agent or trustee to manage, on behalf of the affiliated mutual funds, bank deposit accounts that contain only (i) cash remitted by investors to the affiliated mutual funds for the direct purchase of fund shares, or (ii) cash remitted by the affiliated mutual funds for direct delivery to the investors for either the proceeds of fund shares liquidated at the investors direction, or dividends and capital gains earned on fund shares. As of June 30, 2010 and September 30, 2009, the Company held cash of approximately $171.4 million and $214.5 million off-balance sheet in agency or trust for investors and the affiliated mutual funds.
At June 30, 2010, there were no changes in other commitments and contingencies that would have a material effect on commitments and contingencies reported in the Companys Form 10-K for fiscal year 2009, except for the capital commitments from the issuance of long-term debt as disclosed in Note 10 Debt.
Note 12 - Stock-Based Compensation
The Companys stock-based compensation plans include the Amended and Restated Annual Incentive Compensation Plan (the AIP) and the 2002 Universal Stock Incentive Plan, as amended and restated (the USIP). Under the terms of the AIP, eligible employees may receive cash, equity awards, and/or cash-settled equity awards generally based on the performance of the Company, its funds and the individual employee. The USIP provides for the issuance of up to 30.0 million shares of the Companys common stock for various stock-related awards to officers, directors and employees. At June 30, 2010, approximately 3.5 million shares were available for grant under the USIP. In addition to stock and stock unit awards, the Company may award options and other forms of stock-based compensation to officers, directors and employees under the USIP. The Compensation Committee of the Board of Directors determines the terms and conditions of awards under the AIP and USIP.
24
Stock Options
The following table summarizes stock option activity:
(in thousands, except weighted-average exercise price and remaining |
Shares | Weighted- Average Exercise Price |
Weighted- Average Remaining Contractual Term (in Years) |
Aggregate Intrinsic Value | ||||||||
Outstanding at September 30, 2009 |
2,737 | $ | 37.86 | |||||||||
Exercised |
(475 | ) | 37.72 | |||||||||
Outstanding and Exercisable at June 30, 2010 |
2,262 | $ | 37.89 | 2.0 | $ | 109,265 | ||||||
Stock option awards outstanding under the USIP generally have been granted at prices that are either equal to or above the market value of the underlying shares of the Companys common stock on the date of grant, generally vest over three years and expire no later than ten years after the grant date. No stock option awards have been granted under the USIP since November 2004. All stock options were fully vested and all related compensation cost was recognized prior to fiscal year 2008.
Cash received from stock option exercises for the three and nine months ended June 30, 2010 was $5.1 million and $18.0 million, and $4.8 million and $14.7 million for the three and nine months ended June 30, 2009. Income tax benefits from stock option exercises were $0.9 million and $10.0 million for the three and nine months ended June 30, 2010, and $0.5 million and $4.2 million for the three and nine months ended June 30, 2009.
Stock and Stock Unit Awards
The fair value of stock and stock unit awards granted under the USIP is estimated on the date of grant based on the market price of the underlying shares of the Companys common stock and is amortized to compensation expense on a straight-line basis over the related vesting period, which is generally three to four years. The total number of stock and stock unit awards expected to vest is adjusted for estimated forfeitures.
Total unrecognized compensation cost related to nonvested stock and stock unit awards, net of estimated forfeitures, was $91.4 million at June 30, 2010. This cost is expected to be recognized over a remaining weighted-average vesting period of 1.6 years.
The following table summarizes nonvested stock and stock unit award activity:
| ||||||||||||
(shares in thousands) |
Shares | Weighted- Average Grant- Date Fair Value per Share | ||||||||||
Nonvested balance at September 30, 2009 |
954 | $ | 85.21 | |||||||||
Granted |
820 | 107.10 | ||||||||||
Vested |
(8 | ) | 102.18 | |||||||||
Forfeited/cancelled |
(80 | ) | 94.94 | |||||||||
Nonvested Balance at June 30, 2010 |
1,686 | $ | 95.31 | |||||||||
The stock awards generally entitle holders to the right to sell the underlying shares of the Companys common stock once the awards vest. Stock unit awards generally entitle holders to receive the underlying shares of common stock once the awards vest.
Certain performance-based long-term stock and stock unit awards have been granted to the Companys executive officers and other employees. These awards generally vest over a three-year period based on the achievement of predetermined Company financial performance goals. In the event a performance measure is not achieved at or above a specified threshold level, the portion of the award tied to such performance measure will be forfeited. At June 30, 2010, the balance of nonvested awards was 423.2 thousand and had a weighted-average grant-date fair value of $107.94 per share.
Employee Stock Investment Plan
The amended and restated Franklin Resources, Inc. 1998 Employee Stock Investment Plan (the ESIP) allows eligible participants to buy shares of the Companys common stock at a discount of its market value on defined dates. The Compensation Committee of the Board of Directors determines the terms and conditions of awards under the ESIP. No shares were issued under the ESIP during the three months ended June 30, 2010. A total of 179.0 thousand shares were issued under the ESIP during the nine months ended June 30, 2010. At June 30, 2010, approximately 2.9 million shares were reserved for future issuance under this plan.
25
All Stock-Based Plan Arrangements
Total stock-based compensation costs of $22.3 million and $62.7 million were recognized in the condensed consolidated statements of income for the three and nine months ended June 30, 2010, and $22.1 million and $61.9 million for the three and nine months ended June 30, 2009. The income tax benefits realized from all stock-based arrangements totaled $1.1 million and $10.9 million for the three and nine months ended June 30, 2010, and $0.6 million and $3.3 million for three and nine months ended June 30, 2009.
The Company generally does not repurchase shares upon share option exercise or vesting of stock and stock unit awards. However, in order to pay taxes due in connection with the vesting of employee and executive officer stock and stock unit awards under the USIP, shares are repurchased using a net stock issuance method.
Note 13 - Common Stock Repurchases
During the three and nine months ended June 30, 2010, the Company repurchased 2.1 million and 4.9 million shares of its common stock at a cost of $212.3 million and $503.8 million. The common stock repurchases made as of June 30, 2010 reduced capital in excess of par value to nil and the excess amount was recognized as a reduction to retained earnings. At June 30, 2010, approximately 4.7 million shares of common stock remained available for repurchase under the stock repurchase program. During the three and nine months ended June 30, 2009, the Company repurchased 1.7 million and 3.8 million shares of its common stock at a cost of $109.7 million and $218.7 million. The stock repurchase program is not subject to an expiration date.
Note 14 - Segment Information
The Company bases its operating segment selection process primarily on services offered. The Company derives substantially all of its operating revenues and net income from providing investment management and related services to its sponsored investment products. This is the Companys primary business activity and operating segment. The Companys investment management and related services are marketed to the public globally under six distinct brand names: Franklin, Templeton, Mutual Series, Bissett, Fiduciary Trust and Darby.
The Companys secondary business activity and operating segment is banking/finance. The banking/finance segment offers selected retail banking and consumer lending services and private banking services to high net-worth clients. Consumer lending and retail banking activities include automobile lending services 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, home equity/mortgage lending and other consumer lending.
Financial information for the Companys two operating segments is presented in the table below. Inter-segment transactions are immaterial and excluded from segment income (loss) and assets. Operating revenues of the banking/finance segment are reported net of interest expense, the provision for loan losses and changes in fair value of residual interests from securitization transactions.
Three Months Ended June 30, |
Nine Months
Ended June 30, |
||||||||||||
(in thousands) |
2010 | 2009 | 2010 | 2009 | |||||||||
Operating Revenues |
|||||||||||||
Investment management and related services |
$ | 1,521,687 | $ | 1,062,364 | $ | 4,295,302 | $ | 2,966,243 | |||||
Banking/finance |
12,384 | 11,194 | 29,293 | (11,083 | ) | ||||||||
Total |
$ | 1,534,071 | $ | 1,073,558 | $ | 4,324,595 | $ | 2,955,160 | |||||
Income (Loss) Before Taxes |
|||||||||||||
Investment management and related services |
$ | 475,948 | $ | 418,752 | $ | 1,485,553 | $ | 851,047 | |||||
Banking/finance |
18,848 | 4,300 | 31,884 | (77,064 | ) | ||||||||
Total |
$ | 494,796 | $ | 423,052 | $ | 1,517,437 | $ | 773,983 | |||||
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Operating revenues of the banking/finance operating segment included above were as follows:
Three Months Ended June 30, |
Nine Months
Ended June 30, |
|||||||||||||||
(in thousands) |
2010 | 2009 | 2010 | 2009 | ||||||||||||
Interest and fees on loans |
$ | 4,675 | $ | 4,611 | $ | 13,945 | $ | 15,009 | ||||||||
Interest and dividends on investment securities |
3,520 | 5,083 | 10,805 | 15,528 | ||||||||||||
Total interest income |
8,195 | 9,694 | 24,750 | 30,537 | ||||||||||||
Interest on deposits |
(1,040 | ) | (1,423 | ) | (3,621 | ) | (4,748 | ) | ||||||||
Interest on short-term debt |
(21 | ) | (34 | ) | (32 | ) | (905 | ) | ||||||||
Interest on long-term debt |
(463 | ) | (428 | ) | (1,392 | ) | (1,257 | ) | ||||||||
Total interest expense |
(1,524 | ) | (1,885 | ) | (5,045 | ) | (6,910 | ) | ||||||||
Net interest income |
6,671 | 7,809 | 19,705 | 23,627 | ||||||||||||
Unrealized gains (losses) on trading investments, net |
3,143 | (846 | ) | 2,744 | (44,511 | ) | ||||||||||
Other income |
2,832 | 4,986 | 9,566 | 15,753 | ||||||||||||
Provision for loan losses |
(262 | ) | (755 | ) | (2,722 | ) | (5,952 | ) | ||||||||
Total |
$ | 12,384 | $ | 11,194 | $ | 29,293 | $ | (11,083 | ) | |||||||
Operating segment assets were as follows:
|
||||||||||||||||
(in thousands) |
June 30, 2010 |
September 30, 2009 |
||||||||||||||
Investment management and related services |
$ | 9,433,464 | $ | 8,429,298 | ||||||||||||
Banking/finance |
976,350 | 1,039,165 | ||||||||||||||
Total |
$ | 10,409,814 | $ | 9,468,463 | ||||||||||||
The investment management and related services segment incurs substantially all of the Companys depreciation and amortization costs and expenditures on long-lived assets.
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Note 15 - Other Income (Expenses)
Other income (expenses) consisted of the following:
(in thousands) |
Three Months Ended June 30, |
Nine Months
Ended June 30, |
||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Consolidated Sponsored Investment Products Gains (Losses), Net |
||||||||||||||||
Realized gains (losses), net |
$ | 10,783 | $ | (5,435 | ) | $ | 22,970 | $ | (41,498 | ) | ||||||
Unrealized gains (losses), net |
(25,453 | ) | 49,938 | (16,899 | ) | 27,453 | ||||||||||
Total |
(14,670 | ) | 44,503 | 6,071 | (14,045 | ) | ||||||||||
Investment and Other Income (Losses), Net |
||||||||||||||||
Dividend income |
8,859 | 8,261 | 28,917 | 29,203 | ||||||||||||
Interest income |
2,801 | 6,514 | 9,828 | 26,586 | ||||||||||||
Capital gain distributions |
288 | 36 | 1,176 | 14,309 | ||||||||||||
Other-than-temporary impairment of investment securities, available-for-sale |
0 | (2,092 | ) | (1,463 | ) | (59,744 | ) | |||||||||
Realized gains on sale of investment securities, available-for-sale |
12,642 | 2,478 | 14,867 | 4,438 | ||||||||||||
Realized losses on sale of investment securities, available-for-sale |
(1,263 | ) | (2,393 | ) | (1,743 | ) | (16,874 | ) | ||||||||
Gains (losses) on trading investment securities, net |
1,583 | 18,394 | 23,980 | (29,397 | ) | |||||||||||
Income (losses) from investments in equity method investees |
(37,728 | ) | 27,868 | (20,438 | ) | (8,608 | ) | |||||||||
Foreign currency exchange gains (losses), net |
3,242 | (9,057 | ) | 7,811 | 7,240 | |||||||||||
Other, net |
2,314 | 2,565 | 5,269 | 6,506 | ||||||||||||
Total |
(7,262 | ) | 52,574 | 68,204 | (26,341 | ) | ||||||||||
Interest Expense |
(4,836 | ) | (211 | ) | (6,514 | ) | (3,503 | ) | ||||||||
Other Income (Expenses), Net |
$ | (26,768 | ) | $ | 96,866 | $ | 67,761 | $ | (43,889 | ) | ||||||
Substantially all of the Companys dividend income, capital gain distributions and realized gains and losses on sale of investment securities, available-for-sale were generated by investments in its sponsored investment products. Interest income was primarily generated by investments in debt securities of the U.S. Treasury and federal agencies and cash equivalents. Proceeds from the sale of investment securities, available-for-sale were $73.9 million and $208.7 million for the three and nine months ended June 30, 2010, and $256.9 million and $594.9 million for the three and nine months ended June 30, 2009.
The Company recognized net gains (losses) on trading investment securities, including securities held by consolidated sponsored investment products, that were still held at June 30, 2010 and 2009 in the amounts of $(23.1) million and $2.4 million during the three and nine months ended June 30, 2010, and $56.7 million and $(42.3) million during the three and nine months ended June 30, 2009.
Note 16 - Banking Regulatory Ratios
Franklin is a bank holding company and a financial holding company subject to various regulatory capital requirements administered by federal banking agencies, including the Federal Reserve Board. 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 effect on the Companys consolidated financial statements. The Company must meet specific capital adequacy guidelines that involve quantitative measures of its assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
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Quantitative measures established by regulation to ensure capital adequacy require the Company 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). As of June 30, 2010, the Company revised its calculation methodology to follow the most conservative risk-weighting assumptions within the Federal Reserve Board guidelines. Based on the Companys calculations as of June 30, 2010 and September 30, 2009, it exceeded the applicable capital adequacy requirements as listed below.
(dollar amounts in thousands) |
June 30, 2010 |
September 30, 2009 |
Capital Adequacy Minimum | |||||
Tier 1 capital |
$ | 5,214,547 | $ | 5,495,995 | N/A | |||
Total risk-based capital |
5,220,341 | 5,503,022 | N/A | |||||
Tier 1 leverage ratio |
67% | 75% | 4% | |||||
Tier 1 risk-based capital ratio |
62% | 97% | 4% | |||||
Total risk-based capital ratio |
62% | 97% | 8% |
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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations.
Forward-Looking Statements
In this section, we discuss and analyze the results of operations and financial condition of Franklin Resources, Inc. (Franklin) and its subsidiaries (collectively, the Company). In addition to historical information, we also make statements relating to the future, called forward-looking statements, which are provided under the safe harbor protection of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements are generally written in the future tense and/or are preceded by words such as will, may, could, expect, believe, anticipate, intend, plan, seek, estimate, or other similar words. Moreover, statements that speculate about future events are forward-looking statements. These forward-looking statements involve a number of known and unknown risks, uncertainties and other important factors that could cause 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 based on our current expectations and assumptions regarding our business, the economy and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict. We caution you therefore against relying on any of these forward-looking statements. They are neither statements of historical fact nor guarantees or assurances of future performance.
You should carefully review the Risk Factors section set forth below and in any more recent filings with the SEC, each of which describes these risks, uncertainties and other important factors in more detail. While forward-looking statements are our best prediction at the time that they are made, you should not rely on them. Factors or events that could cause our actual results to differ may emerge from time to time, and it is not possible for us to predict all of them. If a circumstance occurs after the date of this Form 10-Q that causes any of our forward-looking statements to be inaccurate, whether as a result of new information, future developments or otherwise, we do not have an obligation, and we undertake no obligation, to announce publicly the change to our expectations, or to make any revisions to our forward-looking statements, unless required by law.
The following discussion should be read in conjunction with our Form 10-K for the fiscal year ended September 30, 2009 filed with the SEC, and the condensed consolidated financial statements and notes thereto included elsewhere in this Form 10-Q.
Overview
We are a global investment management company and derive substantially all of our operating revenues and net income from providing investment management and related services to our retail and institutional mutual funds, unregistered funds, and to institutional, high net-worth and separately-managed accounts and other investment products. Our services include fund administration, shareholder services, transfer agency, underwriting, distribution, custodial, trustee and other fiduciary services. Our sponsored investment products and investment management and related services are distributed or marketed to the public globally under six distinct brand names: Franklin, Templeton, Mutual Series, Bissett, Fiduciary Trust and Darby.
We offer a broad range of sponsored investment products under equity, hybrid, fixed-income and cash management funds and accounts that meet a wide variety of specific investment needs of individual and institutional investors. Cash management funds consist of U.S.-registered money market funds and non-U.S. registered funds with similar investment objectives.
The level of our revenues depends largely on the level and relative mix of assets under management. As noted in the Risk Factors section set forth below, the amount and mix of our assets under management are subject to significant fluctuations and can negatively impact our revenues and income. To a lesser degree, the level of our revenues also depends 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 is banking/finance. Our banking/finance group offers retail banking and consumer lending services and private banking services to high net-worth clients. Our consumer lending and retail banking activities include automobile lending services 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, home equity/mortgage lending, and other consumer lending.
During the first half of fiscal year 2010, market returns improved as the global economy appeared to emerge from recession and move toward recovery. However, the sovereign debt crisis in Europe led to more turbulent conditions and lower returns throughout the world during the third fiscal quarter, as evidenced by 12% and 11% decreases in the MSCI World Index and the S&P 500 Index. The indexes decreased by 6% and 1% for the nine months ended June 30, 2010.
Our total assets under management at June 30, 2010 were $570.5 billion, 3% lower than the balance at March 31, 2010, but 26% higher than the balance at June 30, 2009. Simple monthly average assets under management for the three and nine months ended June 30, 2010 increased 36% and 31% from the same periods in the prior fiscal year. Net new flows remained strong in our third quarter, totaling $18.8 billion and $50.5 billion for the three and nine months ended June 30, 2010. However, significant market
30
depreciation of $34.5 billion during the quarter eliminated the year-to-date appreciation as of March 31, 2010, resulting in net depreciation of $1.4 billion for the nine month period. Long-term sales activity for the quarter increased 10% from the prior quarter and 83% from the same period in the prior year, mainly due to increases in sales of our global/international taxable fixed-income products.
Our revenues and operating income improved versus the prior fiscal year periods consistent with the improved market conditions and our positive net new flows.
Uncertainties regarding the economic recovery remain in the foreseeable future. As we confront the challenges of this economic environment, we continue to focus on the investment performance of our sponsored investment products and on providing high quality customer service to our clients. While we are focused on expense management, we will also seek to attract, retain and develop employees and invest strategically in systems and technology that will provide a secure and stable environment. We will continue to protect and further our brand recognition while developing and maintaining broker/dealer and client relationships. The success of these and other strategies may be influenced by the factors discussed in the Risk Factors section set forth below.
RESULTS OF OPERATIONS
Three Months Ended June 30, |
Percent Change |
Nine Months
Ended June 30, |
Percent Change | |||||||||||||
(dollar amounts in millions, except per share data) |
2010 | 2009 | 2010 | 2009 | ||||||||||||
Operating Income |
$ | 521.6 | $ | 326.2 | 60% | $ | 1,449.7 | $ | 817.9 | 77% | ||||||
Net Income attributable to Franklin Resources, Inc. |
360.5 | 297.7 | 21% | 1,072.8 | 529.4 | 103% | ||||||||||
Earnings per Share |
||||||||||||||||
Basic |
$ | 1.59 | $ | 1.28 | 24% | $ | 4.70 | $ | 2.28 | 106% | ||||||
Diluted |
1.58 | 1.28 | 23% | 4.68 | 2.27 | 106% | ||||||||||
Operating Margin 1 |
34% | 30% | 34% | 28% |
1 | Defined as operating income divided by total operating revenues. |
Operating income increased for the three and nine months ended June 30, 2010 as compared to the same periods in the prior fiscal year. The increases were primarily due to 47% and 44% increases in investment management revenue, which resulted from 36% and 31% increases in simple monthly average assets under management and higher effective management fee rates during the current fiscal year periods.
Net income attributable to Franklin Resources, Inc. increased for the three months ended June 30, 2010 primarily due to a $195.4 million increase in operating income, partially offset by a $123.6 million decrease in other income (expenses). Other income (expenses) decreased primarily due to current fiscal year losses from equity method investees and consolidated sponsored investment products.
Net income attributable to Franklin Resources, Inc. increased for the nine months ended June 30, 2010 primarily due to a $631.8 million increase in operating income and a $111.7 million increase in other income (expenses). Other income (expenses) increased primarily due to higher investment valuations resulting from improved market conditions.
Diluted earnings per share increased in both periods consistent with the increases in net income as well as 2% decreases in diluted average common shares outstanding resulting primarily from the repurchase of shares of our common stock.
31
Assets Under Management
Assets under management by investment objective were as follows:
(dollar amounts in billions) |
June 30, 2010 |
June 30, 2009 |
Percent Change | |||||
Equity |
||||||||
Global/international |
$ | 172.9 | $ | 153.1 | 13% | |||
Domestic (U.S.) |
63.2 | 56.7 | 11% | |||||
Total equity |
236.1 | 209.8 | 13% | |||||
Hybrid |
101.6 | 85.8 | 18% | |||||
Fixed-Income |
||||||||
Tax-free |
73.8 | 62.4 | 18% | |||||
Taxable |
||||||||
Global/international |
109.4 | 50.2 | 118% | |||||
Domestic (U.S.) |
43.3 | 35.5 | 22% | |||||
Total fixed-income |
226.5 | 148.1 | 53% | |||||
Cash Management1 |
6.3 | 7.5 | (16)% | |||||
Total |
$ | 570.5 | $ | 451.2 | 26% | |||
Simple Monthly Average for the Three-Month Period2 |
$ | 583.1 | $ | 428.0 | 36% | |||
Simple Monthly Average for the Nine-Month Period2 |
$ | 557.6 | $ | 424.6 | 31% | |||
1 | Includes both U.S.-registered money market funds and non-U.S. registered funds with similar investment objectives. |
2 | Investment management fees from approximately 56% of our assets under management at June 30, 2010 were calculated using daily average assets under management. |
Assets under management at June 30, 2010 were 26% higher than they were at June 30, 2009, primarily due to positive net new flows of $62.7 billion and market appreciation of $59.3 billion during the twelve-month period. The increases occurred in both equity and fixed-income products as improved market conditions led to significant valuation increases, higher sales and lower redemptions. Simple monthly average assets under management, which are generally more indicative of trends in revenue for providing investment management and fund administration services than the year over year change in ending assets under management, increased 36% and 31% during the three and nine months ended June 30, 2010, as compared to the same periods in the prior fiscal year.
The simple monthly average mix of assets under management is shown below. The change in mix for the nine months ended June 30, 2010 as compared to the same period in the prior fiscal year reflects an investor shift to lower risk investments during the prior twelve months.
Nine Months Ended June 30, | ||||
2010 | 2009 | |||
Equity |
45% | 47% | ||
Hybrid |
18% | 19% | ||
Fixed-income |
36% | 32% | ||
Cash management |
1% | 2% | ||
Total |
100% | 100% | ||
32
Assets under management by sales region were as follows:
(dollar amounts in billions) |
June 30, 2010 |
Percent of Total |
June 30, 2009 |
Percent of Total | ||||||
United States1 |
$ | 409.9 | 72% | $ | 339.2 | 75% | ||||
Europe2 |
72.0 | 13% | 44.6 | 10% | ||||||
Asia-Pacific3 |
59.6 | 10% | 41.0 | 9% | ||||||
Canada |
29.0 | 5% | 26.4 | 6% | ||||||
Total |
$ | 570.5 | 100% | $ | 451.2 | 100% | ||||
1 | Approximately 67% and 70% of our operating revenues originated from U.S. operations in the nine months ended June 30, 2010 and 2009. |
2 | Europe sales region includes Middle East and Africa. |
3 | Asia-Pacific sales region includes Latin America and Australia. |
Due to the global nature of our business operations, investment management and related services may be performed in locations unrelated to the sales region.
Components of the change in our assets under management were as follows:
(dollar amounts in billions) |
Three Months Ended June 30, |
Percent Change |
Nine Months
Ended June 30, |
Percent Change | ||||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||||||
Beginning assets under management |
$ | 586.8 | $ | 391.1 | 50% | $ | 523.4 | $ | 507.3 | 3% | ||||||||||
Long-term sales |
51.0 | 27.9 | 83% | 139.6 | 75.5 | 85% | ||||||||||||||
Long-term redemptions |
(33.6 | ) | (22.4 | ) | 50% | (91.1 | ) | (92.3 | ) | (1)% | ||||||||||
Net cash management |
1.4 | 0.5 | 180% | 2.0 | (0.9 | ) | NM | |||||||||||||
Net new flows |
18.8 | 6.0 | 213% | 50.5 | (17.7 | ) | NM | |||||||||||||
Reinvested distributions |
3.1 | 2.7 | 15% | 8.9 | 11.7 | (24)% | ||||||||||||||
Net flows |
21.9 | 8.7 | 152% | 59.4 | (6.0 | ) | NM | |||||||||||||
Distributions |
(3.7 | ) | (3.3 | ) | 12% | (10.9 | ) | (14.8 | ) | (26)% | ||||||||||
Appreciation (depreciation) and other |
(34.5 | ) | 54.7 | NM | (1.4 | ) | (35.3 | ) | (96)% | |||||||||||
Ending Assets Under Management |
$ | 570.5 | $ | 451.2 | 26% | $ | 570.5 | $ | 451.2 | 26% | ||||||||||
Assets under management decreased during the three months ended June 30, 2010, resulting from market depreciation of $34.5 billion, primarily in our equity products, partially offset by positive net new flows of $18.8 billion, primarily in our fixed-income products.
Assets under management increased during the nine months ended June 30, 2010, resulting from $50.5 billion of positive net new flows, primarily in our fixed-income products, partially offset by $1.4 billion of market depreciation, primarily in our equity products.
Investment Management Fee Rate
Our effective investment management fee rate (investment management fees divided by simple monthly average assets under management) increased to 0.612% for the nine months ended June 30, 2010 from 0.559% for the same period in the prior fiscal year. The increase was primarily due to higher levels of global/international assets under management and performance fees earned. Generally, investment management fees earned on global/international products are higher than fees earned on domestic (U.S.) products.
33
Operating Revenues
The table below presents the percentage change in each revenue category.
(dollar amounts in millions) |
Three Months Ended June 30, |
Percent Change |
Nine Months
Ended June 30, |
Percent Change | |||||||||||||
2010 | 2009 | 2010 | 2009 | ||||||||||||||
Investment management fees |
$ | 915.9 | $ | 625.0 | 47% | $ | 2,558.6 | $ | 1,778.2 | 44% | |||||||
Underwriting and distribution fees |
529.3 | 365.2 | 45% | 1,514.1 | 974.8 | 55% | |||||||||||
Shareholder servicing fees |
73.0 | 67.1 | 9% | 214.0 | 200.0 | 7% | |||||||||||
Consolidated sponsored investment products income, net |
1.4 | 2.9 | (52)% | 2.4 | 6.6 | (64)% | |||||||||||
Other, net |
14.5 | 13.4 | 8% | 35.5 | (4.4 | ) | NM | ||||||||||
Total Operating Revenues |
$ | 1,534.1 | $ | 1,073.6 | 43% | $ | 4,324.6 | $ | 2,955.2 | 46% | |||||||
Investment Management Fees
Investment management fees are generally calculated under contractual arrangements with our sponsored investment products and sub-advised accounts 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 for the three and nine months ended June 30, 2010 primarily due to 36% and 31% increases in simple monthly average assets under management. The increases were also impacted by higher effective management fee rates during both periods.
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 some sale transactions depending upon the amount invested and the type of investor. Therefore, underwriting fees will change with the overall level of gross sales, the size of individual transactions, and the relative mix of sales between different share classes and types of investors.
Globally, our mutual funds and certain other products generally pay us distribution fees in return for sales, marketing and distribution efforts on their behalf. Specifically, the majority of U.S.-registered mutual funds, with the exception of certain of our money market mutual funds, have adopted distribution plans (the Plans) under Rule 12b-1 promulgated under the Investment Company Act of 1940, as amended (Rule 12b-1). The Plans permit the mutual funds to bear certain expenses relating to the distribution of their shares, such as expenses for marketing, advertising, printing and sales promotion, subject to the Plans limitations on amounts. The individual Plans set a percentage limit for Rule 12b-1 expenses based on average daily net assets under management of the mutual fund. Similar arrangements exist for the distribution of our non-U.S. funds and where, generally, the distributor of the funds in the local market arranges for and pays commissions.
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.
Overall, underwriting and distribution fees increased for the three and nine months ended June 30, 2010. Underwriting fees increased 50% and 84% primarily due to 66% and 109% increases in gross commissionable sales, partially offset by a shift in sales from equity products to fixed-income products, which typically generate lower underwriting fees. Distribution fees increased 42% for the three and nine months ended June 30, 2010 primarily due to 36% and 31% increases in simple monthly average assets under management.
Shareholder Servicing Fees
We receive shareholder servicing fees as compensation for providing transfer agency services, which include providing customer statements, transaction processing, customer service, and tax reporting. These fees are generally fixed charges per shareholder account that vary with the particular type of fund and the service being rendered. In some instances, we charge sponsored investment products these fees based on the level of assets under management. 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 change in open accounts and the level of closed accounts that remain billable. Approximately 3.2 million accounts closed in the U.S. during calendar year 2009 were no longer billable effective July 1, 2010, as compared to approximately 2.1 million accounts closed during calendar year 2008 that were no
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longer billable effective July 1, 2009. Approximately 235.6 thousand accounts closed in Canada during calendar year 2009 were no longer billable effective May 1, 2010, as compared to approximately 300.0 thousand accounts closed during calendar year 2008 that were no longer billable effective May 1, 2009.
Shareholder servicing fees increased for the three and nine months ended June 30, 2010 primarily due to 5% increases in simple monthly average billable shareholder accounts and favorable currency impacts during both periods. The account increases were predominantly related to shareholder accounts originated in the United States. The favorable currency impacts mainly resulted from 14% and 16% increases in the value of the Canadian dollar against the U.S. dollar during the three and nine month periods.
Consolidated Sponsored Investment Products Income, Net
Consolidated sponsored investment products income, net reflects the net investment income, including dividend and interest income, of sponsored investment products that we consolidate in our financial statements.
Consolidated sponsored investment products income, net decreased for the three and nine months ended June 30, 2010, reflecting investment performance and net asset balances of the specific sponsored investment products that we consolidated during each period and the deconsolidation of certain sponsored investment products during each period.
Other, Net
Other, net revenue primarily consists of revenues from the banking/finance segment as well as income from custody services. Banking/finance revenues include interest income on loans, servicing income, and realized and unrealized gains (losses) on residual interests from securitization transactions, and are reduced by interest expense and the provision for loan losses.
Other, net revenue increased for the three and nine months ended June 30, 2010 primarily due to gains from increases in the fair value of retained interests from securitizations of $3.1 million and $2.7 million, compared to losses from decreases in fair value during the same periods in the prior fiscal year of $0.8 million and $44.5 million. The increases were partially offset by $1.8 million and $5.9 million decreases in servicing fees from automobile loans.
Operating Expenses
The table below presents the percentage change in each expense category.
Three Months Ended June 30, |
Percent Change |
Nine Months Ended June 30, |
Percent Change | |||||||||||||
(dollar amounts in millions) |
2010 | 2009 | 2010 | 2009 | ||||||||||||
Underwriting and distribution |
$ | 519.6 | $ | 350.7 | 48% | $ | 1,473.7 | $ | 933.7 | 58% | ||||||
Compensation and benefits |
280.3 | 230.9 | 21% | 805.7 | 711.7 | 13% | ||||||||||
Information systems, technology and occupancy |
76.0 | 68.2 | 11% | 214.2 | 202.2 | 6% | ||||||||||
Advertising and promotion |
38.0 | 27.9 | 36% | 110.9 | 78.8 | 41% | ||||||||||
Amortization of deferred sales commissions |
50.1 | 32.9 | 52% | 143.0 | 103.2 | 38% | ||||||||||
Other |
48.5 | 36.8 | 32% | 127.4 | 107.7 | 18% | ||||||||||
Total Operating Expenses |
$ | 1,012.5 | $ | 747.4 | 35% | $ | 2,874.9 | $ | 2,137.3 | 35% | ||||||
Underwriting and Distribution
Underwriting and distribution expenses include payments to financial advisers and other third parties for providing sales, marketing and distribution services to investors in our sponsored investment products. The increases in underwriting and distribution expenses for the three and nine months ended June 30, 2010 were consistent with the 45% and 55% increases in underwriting and distribution revenues during the same periods.
Compensation and Benefits
Compensation and benefit expenses increased for the three and nine months ended June 30, 2010 primarily due to increases in variable compensation and commissions, partially offset by decreases related to severance costs incurred in the prior fiscal year. Variable compensation increases of $34.8 million and $111.6 million were mainly due to higher bonus expense based on our performance. Commissions increased $8.3 million and $20.1 million, reflecting higher levels of sponsored investment product sales.
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Severance costs of $0.1 million and $36.8 million were recognized in the three and nine months ended June 30, 2009 related to reductions in our global workforce of approximately 10% announced during the first half of fiscal year 2009. Lower salaries, wages and benefits resulting from reduced staffing levels during the current fiscal year were offset by unfavorable currency impacts and annual merit salary adjustments effective December 1, 2009. The level of our global workforce throughout the current year was lower than in each of the same periods in the prior fiscal year until June 2010. At June 30, 2010, our global workforce had increased to approximately 7,900 employees from approximately 7,800 employees at June 30, 2009.
We continue to place a high emphasis on our pay for performance philosophy. As such, any changes in the underlying performance of our sponsored investment products or changes in the composition of our incentive compensation offerings could have an impact on compensation and benefit expenses going forward. However, in order to attract and retain talented individuals, our level of compensation and benefit expenses may increase more quickly or decrease more slowly than our revenue.
Information Systems, Technology and Occupancy
Information systems, technology and occupancy costs increased for the three and nine months ended June 30, 2010 primarily due to non-recurring occupancy costs of approximately $6.0 million relating to a property sublease.
Details of capitalized information systems and technology costs, which exclude occupancy costs, are shown below.
Three Months Ended June 30, |
Nine Months Ended June 30, |
|||||||||||||||
(in millions) |
2010 | 2009 | 2010 | 2009 | ||||||||||||
Net carrying value at beginning of period |
$ | 56.9 | $ | 67.9 | $ | 65.2 | $ | 66.5 | ||||||||
Additions during period, net of disposals |
10.4 | 4.9 | 18.9 | 22.3 | ||||||||||||
Amortization during period |
(9.0 | ) | (7.9 | ) | (25.8 | ) | (23.9 | ) | ||||||||
Net Carrying Value at End of Period |
$ | 58.3 | $ | 64.9 | $ | 58.3 | $ | 64.9 | ||||||||
Advertising and Promotion
Advertising and promotion expenses increased for the three and nine months ended June 30, 2010 primarily due to $6.5 million and $26.6 million increases in marketing support payments to intermediaries resulting from higher product sales and assets under management.
We are committed to investing in advertising and promotion in response to changing business conditions, and to advance our products where we see continued or potential new growth opportunities. As a result of potential changes in our strategic marketing campaigns, 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 sold globally, including Class C and Class R shares marketed in the United States, are sold without a front-end sales charge to shareholders, although our distribution subsidiaries pay an up-front commission to financial intermediaries on these sales. In addition, certain share classes, such as Class A shares sold in the United States, are sold without a front-end sales charge to shareholders when minimum investment criteria are met, although our distribution subsidiaries pay an up-front commission to financial intermediaries on these sales. We defer all up-front commissions paid by our distribution subsidiaries and amortize them over the periods in which commissions are generally recovered from distribution and service fee revenues and contingent sales charges received from shareholders of the funds upon redemption of their shares. We evaluate deferred commission assets (DCA) for recoverability on a periodic basis using undiscounted expected cash flows from the shares of mutual funds sold without a front-end sales charge.
We previously held 49% ownership interests in Lightning Finance Company Limited (LFL) and Lightning Asset Finance Limited (LAFL). Due to our significant interest in LAFL, we carried on our consolidated balance sheets the DCA generated in the United States and the financing liability for the related future revenue we previously sold to LFL, which was subsequently transferred to LAFL. We repurchased the remaining DCA from LAFL in September 2009 and liquidated our ownership interests in LFL and LAFL during the three months ended December 31, 2009.
Amortization of deferred sales commissions increased for the three and nine months ended June 30, 2010 mainly due to higher product sales with up-front commissions in fiscal year 2010, primarily related to U.S. funds. Accelerated amortization of the DCA repurchased from LAFL also contributed to the increase for the nine-month period.
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Other Operating Expenses
Other operating expenses primarily consist of professional fees, fund administration services and shareholder servicing fees payable to external parties, corporate travel and entertainment, and other miscellaneous expenses.
Other operating expenses increased for the three and nine months ended June 30, 2010 primarily due to $10.2 million and $16.3 million increases in fund administration services and shareholder servicing fees payable to external parties, which resulted from higher average assets under management.
Other Income (Expenses)
Three Months Ended June 30, |
Nine Months Ended June 30, |
|||||||||||||||
(in millions) |
2010 | 2009 | 2010 | 2009 | ||||||||||||
Consolidated sponsored investment products gains (losses), net |
$ | (14.7 | ) | $ | 44.5 | $ | 6.1 | $ | (14.1 | ) | ||||||
Investment and other income (losses), net |
(7.3 | ) | 52.6 | 68.2 | (26.3 | ) | ||||||||||
Interest expense |
(4.8 | ) | (0.2 | ) | (6.5 | ) | (3.5 | ) | ||||||||
Other income (expenses), net |
$ | (26.8 | ) | $ | 96.9 | $ | 67.8 | $ | (43.9 | ) | ||||||
Other income (expenses) includes net realized and unrealized investment gains (losses) on consolidated sponsored investment products, investment and other income (losses), net and interest expense from our investment management and related services business. Investment and other income (losses), net is comprised primarily of income related to our investments, including interest and dividend income, realized gains and losses on sale of and other-than-temporary impairments of available-for-sale investment securities, gains (losses) from trading investments, income (losses) from equity method investees, and foreign currency exchange gains and losses.
Other income (expenses) decreased to a net loss position for the three months ended June 30, 2010, as compared to a net income position in the prior fiscal year, primarily due to lower investment valuations. The market conditions resulted in net losses from equity method investees of $37.7 million and securities held by our consolidated sponsored investment products of $14.7 million, compared to net gains of $27.9 million and $44.5 million in the prior fiscal year. Additionally, net gains from trading investments decreased by $16.8 million. These decreases were partially offset by increases of $12.8 million in realized gains on sale of available-for-sale investment securities and $12.3 million in foreign currency exchange gains.
Other income (expenses) increased to a net income position for the nine months ended June 30, 2010, as compared to a net loss position in the prior fiscal year, primarily due to higher investment valuations during the first half of the current fiscal year. The market recovery resulted in a $58.3 million decrease in other-than-temporary impairments of available-for-sale investments, and current year net gains from trading investments of $24.0 million, sale of available-for-sale investment securities of $13.1 million and securities held by our consolidated sponsored investment products of $6.1 million, compared to net losses of $29.4 million, $12.4 million and $14.1 million in the prior fiscal year. These increases were partially offset by reductions of $16.8 million in interest income, $13.6 million in capital gain distributions and $11.8 million in income from equity method investees.
Our investments in sponsored investment products primarily consist of the initial cash investments made in the course of launching mutual fund and other investment product offerings; however we may also invest in our products for other business reasons. The market conditions that impact our assets under management similarly affect the investment income earned or losses incurred on our sponsored investment product investments.
Taxes on Income
As a multinational corporation, we provide investment management and related 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 and related services business) subject to these lower rates, when aggregated with income originating in the United States, produces a lower overall effective income tax rate than existing U.S. federal and state income tax rates.
Our effective income tax rates were 27.31% and 29.11% for the three and nine months ended June 30, 2010, as compared to 27.47% and 32.06% for the same periods in the prior fiscal year. The decreases were primarily due to a change in the mix of earnings combined with a favorable international tax ruling.
The effective income tax rate for future reporting periods will continue to reflect the relative contributions of non-U.S. earnings that are subject to reduced tax rates and that are not currently included in U.S. taxable income.
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LIQUIDITY AND CAPITAL RESOURCES
The following table summarizes certain key financial data relating to our liquidity, capital resources and uses of capital:
(in millions) |
June 30, 2010 |
September 30, 2009 |
||||||
Balance Sheet Data |
||||||||
Assets |
||||||||
Liquid assets |
$ | 6,458.8 | $ | 5,832.6 | ||||
Cash and cash equivalents |
$ | 3,990.6 | $ | 3,104.5 | ||||
Liabilities |
||||||||
Debt |
||||||||
Commercial paper |
$ | 0 | $ | 64.2 | ||||
Federal Home Loan Bank (FHLB) advances |
51.0 | 57.0 | ||||||
Long-term debt |
898.8 | 0 | ||||||
Total debt |
$ | 949.8 | $ | 121.2 | ||||
Nine Months Ended June 30, |
||||||||
(in millions) |
2010 | 2009 | ||||||
Cash Flow Data |
||||||||
Operating cash flows |
$ | 1,339.9 | $ | 489.0 | ||||
Investing cash flows |
(9.4 | ) | (374.2 | ) | ||||
Financing cash flows |
(414.6 | ) | (254.6 | ) |
Liquidity
Liquid assets consist of cash and cash equivalents, current receivables, and current and certain other investments (trading, available-for-sale and other). Cash and cash equivalents include cash on hand, non-interest-bearing and interest-bearing deposits with financial institutions, federal funds sold, time deposits, U.S. government-sponsored enterprise obligations, securities of the U.S. Treasury and federal agencies, debt instruments with original maturities of three months or less at the purchase date and other highly liquid investments, including money market funds, which are readily convertible into cash. Cash and cash equivalents at June 30, 2010 increased primarily due to net cash provided by operating activities, partially offset by net cash used in financing activities. At June 30, 2010, the percentages of cash and cash equivalents held by our U.S. and non-U.S. operations were approximately 48% and 52%, as compared to approximately 49% and 51% at September 30, 2009. The percentage of cash and cash equivalents held by our U.S. operations decreased slightly primarily due to dividends paid to our shareholders and common stock repurchases, partially offset by proceeds from the issuance of long-term debt.
The increase in total debt outstanding during the nine months ended June 30, 2010 primarily relates to the issuance of long-term debt in May 2010, partially offset by the repayment of previously issued commercial paper.
We experienced an increase in net cash provided by operating activities during the nine months ended June 30, 2010, as compared to the same period in the prior fiscal year, primarily due to an increase in net income. Net cash used in investing activities decreased mainly due to a decrease in purchases of investments, partially offset by a decrease in liquidations of investments and an increase in loans receivable. Net cash used in financing activities increased during the nine months ended June 30, 2010, as compared to the same period in prior fiscal year, primarily due to increased dividends paid on common stock and common stock repurchases, partially offset by proceeds from the issuance of long-term debt.
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 and the ability to issue additional debt or equity securities.
In March 2008, we filed an automatic shelf registration statement with the SEC as a well-known seasoned issuer. Using the shelf registration statement, we may sell, at any time and from time to time, in one or more offerings, our shares of common stock, shares of preferred stock, debt securities, convertible securities, warrants or units.
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In May 2010, we completed the issuance of senior unsecured and unsubordinated notes with a face value of $900.0 million. The net proceeds from the issuance of the notes are available for general corporate purposes; a portion of the proceeds has been used for the repayment of previously issued commercial paper. Of the notes, $300.0 million was issued at a fixed interest rate of 2.000% per annum and matures in 2013, $250.0 million was issued at a fixed interest rate of 3.125% per annum and matures in 2015 and $350.0 million was issued at a fixed interest rate of 4.625% and matures in 2020. Interest is payable semi-annually. The notes were issued collectively at a discount of $1.2 million that is being amortized over the term of the notes. We incurred approximately $6.4 million in debt issuance costs, which are included in other non-current assets in the condensed consolidated balance sheet and are being amortized over the term of the notes. The notes contain an optional redemption feature that allows us to redeem each series of notes prior to maturity in whole or in part at any time, at a make-whole redemption price. The indenture governing the notes contains limitations on our ability and the ability of our subsidiaries to pledge voting stock or profit participating equity interests in our subsidiaries to secure other debt without similarly securing the notes equally and ratably. The indenture also includes requirements that must be met if we consolidate or merge with, or sell all or substantially all of our assets to, another entity. As of June 30, 2010, we were in compliance with the covenants of the notes.
The banking/finance segment secures advances from the FHLB to fund its retail banking and consumer lending services. At June 30, 2010, we had $51.0 million of FHLB advances outstanding. These advances had a weighted-average interest rate of 3.64% at June 30, 2010 and are subject to collateralization requirements.
At June 30, 2010, we had $500.0 million of short-term commercial paper available for issuance under an uncommitted private placement program and $14.1 million available in uncommitted short-term bank lines of credit. Our banking/finance segment had $295.0 million available in uncommitted short-term bank lines of credit under the Federal Reserve system, $209.1 million available through the secured Federal Reserve Bank short-term discount window and $56.3 million available in secured FHLB short-term borrowing capacity. On June 9, 2010, our $420.0 million five-year revolving credit facility expired with no borrowings outstanding.
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. If we are unable to access capital markets in a timely manner, our business could be adversely impacted.
Uses of Capital
We expect that our 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 stockholder dividends and repay and service debt.
On June 15, 2010, our Board of Directors declared a regular quarterly cash dividend of $0.22 per share which was payable on July 9, 2010 to stockholders of record on June 30, 2010.
We maintain a stock repurchase program to manage our equity capital with the objective of maximizing shareholder value. Our stock repurchase program is affected through regular open-market purchases and private transactions in accordance with applicable laws and regulations. During the three and nine months ended June 30, 2010, we repurchased 2.1 million and 4.9 million shares of our common stock at costs of $212.3 million and $503.8 million. The common stock repurchases made as of June 30, 2010 reduced our capital in excess of par value to nil and the excess amount was recognized as a reduction to retained earnings. At June 30, 2010, approximately 4.7 million shares of our common stock remained available for repurchase under our stock repurchase program. Our stock repurchase program is not subject to an expiration date.
The funds that we manage have their own resources available for purposes of providing liquidity to meet shareholder redemptions, including securities that can be sold or provided to investors as in-kind redemptions, and lines of credit. While we have no contractual obligation to do so, we may voluntarily elect to provide the funds with direct or indirect financial support based on our business objectives.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
Our contractual obligations and commercial commitments are summarized in our Form 10-K for the fiscal year ended September 30, 2009. At June 30, 2010, there were no material changes outside the ordinary course in our contractual obligations and commercial commitments from September 30, 2009, except for our capital commitments from the issuance of long-term debt disclosed in Note 10 Debt in the notes to the condensed consolidated financial statements in Item 1 of Part I of this Form 10-Q.
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OFF-BALANCE SHEET ARRANGEMENTS
Our banking/finance operating segment periodically enters into automobile loan securitization transactions with qualified special purpose entities, which then issue asset-backed securities to private investors (see Note 8 Securitization of Loans Held for Sale in the notes to the condensed consolidated financial statements in Item 1 of Part I of this Form 10-Q). Our main objective in entering into these securitization transactions is to obtain financing for automobile loan activities. Securitized loans held by the securitization trusts totaled $371.0 million at June 30, 2010 and $551.4 million at September 30, 2009.
In our role as agent or trustee, we facilitate the settlement of investor share purchase, redemption, and other transactions with affiliated mutual funds. We are appointed by the affiliated mutual funds as agent or trustee to manage, on behalf of the affiliated mutual funds, bank deposit accounts that contain only (i) cash remitted by investors to the affiliated mutual funds for the direct purchase of fund shares, or (ii) cash remitted by the affiliated mutual funds for direct delivery to the investors for either the proceeds of fund shares liquidated at the investors direction, or dividends and capital gains earned on fund shares. As of June 30, 2010 and September 30, 2009, we held cash of approximately $171.4 million and $214.5 million off-balance sheet in agency or trust for investors and the affiliated mutual funds.
CRITICAL ACCOUNTING POLICIES
Our consolidated financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America, which require the use of estimates, judgments, and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. Actual results may differ from those estimates under different assumptions. Following are updates to our critical accounting policies disclosed in Managements Discussion and Analysis of Financial Condition and Results of Operations in our Form 10-K for the fiscal year ended September 30, 2009.
Fair Value Measurements
We record substantially all of our investments in the consolidated financial statements at fair value or amounts that approximate fair value. We use a three-level fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value based on whether the inputs to those valuation techniques are observable or unobservable.
Level 3 assets represented approximately 2.2% of total assets measured at fair value at June 30, 2010 and Level 3 liabilities measured at fair value were insignificant. There were no transfers into and immaterial transfers out of Level 3 during the nine months ended June 30, 2010.
Goodwill and Other Intangible Assets
We make significant estimates and assumptions when valuing goodwill and other intangible assets in connection with the initial purchase price allocation of an acquired entity, as well as when evaluating impairment of goodwill and other intangible assets on an ongoing basis.
Goodwill is tested for impairment annually and when an event occurs or circumstances change that more likely than not reduce the fair value of a reporting unit below its carrying value. Indefinite-lived intangible assets are tested for impairment annually and when events or changes in circumstances indicate the assets might be impaired. Impairment is indicated when the carrying value of the intangible asset exceeds its fair value.
We performed our annual impairment tests for goodwill and indefinite-lived intangible assets as of August 1, 2009. We did not recognize any impairment because our estimates of the fair values of our reporting unit and our indefinite-lived assets exceeded their respective carrying values. A hypothetical 500 basis point decline in the assets under management growth rate or a 500 basis point increase in the discount rate would not have caused either the investment management and related services reporting unit or the management contracts to fail step one of the impairment tests for goodwill or indefinite-lived intangible assets.
We subsequently monitor the market conditions and their potential impact on the assumptions used in the annual calculations of fair value to determine whether circumstances have changed that would more likely than not reduce the fair value of our reporting unit below its carrying value, or indicate that our indefinite-lived intangible assets might be impaired. We consider, among other things, changes in our assets under management and pre-tax profit margin amounts, which affect our revenue growth rate assumptions, by assessing whether these changes would impact the reasonableness of the assumptions used in our impairment test as of August 1, 2009. We also monitor fluctuations of our common stock per share price to evaluate our market capitalization relative to the reporting unit as a whole.
As of June 30, 2010, approximately 11% of our indefinite-lived intangible assets related to investment management contracts of Franklin Templeton Asset Management (India) Private Limited (FTAMIPL). As a result of recent clarifications made to regulations implemented in 2009 by the Securities and Exchange Board of India, certain expenses are expected to increase which
40
will negatively impact FTAMIPLs pre-tax profit margin and therefore indicated potential impairment of its indefinite-lived intangible assets. We tested these intangible assets for impairment as of June 30, 2010, and the related discounted future cash flow projections exceeded their carrying values by approximately 60%. The assumptions used in our impairment test for FTAMIPL indefinite-lived intangible assets were developed taking into consideration ongoing regulatory and market conditions. As of June 30, 2010, a decline in the pre-tax profit margin of approximately 800 basis points may cause the fair value of these indefinite-lived intangible assets to be below the asset carrying value.
We determined that no events occurred or circumstances changed subsequent to August 1, 2009 that would more likely than not reduce the fair value of the reporting unit below its carrying value, or indicate that our indefinite-lived intangible assets other than those related to FTAMIPL might be impaired. Accordingly, there were no impairments to goodwill or indefinite-lived intangible assets.
We test definite-lived intangible assets for impairment quarterly. As of June 30, 2010, approximately 90% of our definite-lived intangible assets related to investment management contracts of Fiduciary Trust Company International (FTCI). The undiscounted future cash flow projections for FTCI institutional and high net-worth management contracts exceeded their carrying values by approximately 50% and 10%, respectively. We estimated the undiscounted future cash flows using assets under management growth rates ranging from -6.2% to 6.0% depending on the type of management contracts. The undiscounted future cash flow projections for the other definite-lived intangible assets exceeded their respective carrying values by more than 100%. The assumptions used in our impairment tests for definite-lived intangible assets were developed taking into consideration ongoing market conditions. As of June 30, 2010, a decline in the assets under management of approximately 800 basis points could cause us to evaluate whether the fair value of our definite-lived intangible assets is below the asset carrying value.