Forward-Looking Statements

In this section, we discuss and analyze the results of operations and financial condition of the Company and its subsidiaries. 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 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", 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 the actual results and outcomes to differ materially from any future results or outcomes expressed or implied by such forward-looking statements. 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. If a circumstance occurs after the date of this Form 10-Q that causes any of our forward-looking statements to be inaccurate, 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, 2008 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 the majority of our operating revenues and net income from providing investment management and related services to our retail mutual 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 money market categories that meet a wide variety of specific investment needs of individual and institutional investors.

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 could negatively impact our revenues and income. To a lesser degree, our revenues also depend on the level of mutual fund sales and the number of mutual fund shareholder accounts. The fees charged for our services are based on contracts with our sponsored investment products or our clients. These arrangements could change in the future.

Our secondary business 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 related to the purchase, securitization, and servicing of retail installment sales contracts originated by independent automobile dealerships, consumer credit and debit cards, real estate equity lines, and home equity/mortgage lending.

During the three months ended December 31, 2008, the ongoing global financial crisis worsened and the economy deteriorated into a recession. The turmoil in the global financial markets, evidenced by a 22% decrease in both the MSCI World and S&P 500 indexes during the quarter, has impacted the entire asset management industry. The unprecedented downturn in the markets has significantly affected our assets under management, fee revenues and non-operating income, all of which decreased sharply during the quarter. We expect that the market conditions will continue to put pressure on our financial results throughout fiscal year 2009.

We have taken steps to manage our business and our cost structure to respond to the market conditions and resulting decrease in revenue, including reducing expenditures in areas such as travel and entertainment, advertising, and contractor and professional fees, and deferring non-business critical initiatives and hiring. In addition, we deferred the launch of new investment products and merged products that have not met their growth objectives. We also announced a reduction in our workforce of approximately 2% during the quarter and an additional 4% in January 2009, and did not provide annual merit salary increases. We are continuing to assess and implement cost reduction measures as we adapt to the unprecedented changes affecting our industry.

Challenging market conditions continued to persist as of the beginning of calendar year 2009 and remain in the forecast for the foreseeable future. As we confront the challenges of this economic environment, we expect to continue to focus on the investment performance of our sponsored investment products and to provide high quality customer service to our clients. While we are focused on reducing costs, we will also seek to attract, retain and develop employees and invest strategically in systems and technology that will provide secure, stable environments and economies of scale. 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
                                                            December 31,        Percent
 (dollar amounts in millions, except per share data)      2008         2007     Change
 Operating Income                                      $    268.4    $  635.7     (58)%
 Net Income                                                 120.9       518.3     (77)%
 Earnings Per Share
 Basic                                                 $     0.52    $   2.15     (76)%
 Diluted                                                     0.52        2.12     (75)%
 Operating Margin 1                                           28%         38%

1 Defined as operating income divided by total operating revenues.

Operating income decreased 58% during the three months ended December 31, 2008 as compared to the same period in the prior year. Adverse market conditions led to a 42% decrease in operating revenues as we experienced a 33% decrease in our simple monthly average assets under management and a higher proportion of fixed-income assets under management. As described above, we have taken actions to reduce our operating expenses in response to the market conditions and resulting revenue decreases, contributing to a 33% operating expense decrease as compared to the same period in the prior fiscal year.

Net income decreased 77% for the three months ended December 31, 2008, resulting from a $367.3 million decline in operating income and a $156.4 million decline in non-operating income. Other income (expenses), net was significantly impacted by lower investment valuations during the quarter, resulting in losses of $82.7 million as compared to income of $73.8 million in the same period in the prior fiscal year. Decreased fair values of the underlying securities in our consolidated sponsored investment products and in our other trading investments, other-than-temporary impairments and realized losses from our available-for-sale investments, and losses from equity method investees were the primary causes of the non-operating losses.

ASSETS UNDER MANAGEMENT

Assets under management by investment objective were as follows:



                                                      December 31,     December 31,     Percent
(dollar amounts in billions)                              2008             2007         Change
Equity
Global/international                                  $       142.6    $       286.1      (50)%
Domestic (U.S.)                                                55.2             95.8      (42)%

Total equity                                                  197.8            381.9      (48)%

Hybrid                                                         78.8            116.4      (32)%
Fixed-Income
Tax-free                                                       56.1             59.3       (5)%
Taxable
Global/international                                           45.9             48.3       (5)%
Domestic (U.S.)                                                29.8             31.5       (5)%

Total fixed-income                                            131.8            139.1       (5)%
Money Market                                                    7.8              6.3        24%

Total                                                 $       416.2    $       643.7      (35)%

Simple Monthly Average for the Three-Month Period1    $       438.7    $       651.5      (33)%

1 Investment management fees from approximately 51% of our assets under management at December 31, 2008 were calculated using daily average assets under management.

Assets under management at December 31, 2008 were 35% lower than they were at December 31, 2007, primarily due to market depreciation of $191.2 billion and negative net flows of $31.7 billion during the twelve month period. The reductions occurred predominantly in equity products as market volatility led to significant valuation decreases and a shift in investor demand to lower risk investments. 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, decreased 33% during the year.

The simple monthly average mix of assets under management is shown below. The change in mix for the three months ended December 31, 2008 as compared to the same period in the prior fiscal year reflects an investor shift to lower risk investments during the prior twelve months.

                                        Three Months Ended
                                           December 31,
                                         2008        2007
                        Equity              49%         60%
                        Hybrid              19%         18%
                        Fixed-income        30%         21%
                        Money market         2%          1%

                        Total              100%        100%

Assets under management by sales region were as follows:

                                   December 31,    Percent    December 31,    Percent
    (dollar amounts in billions)       2008        of Total       2007        of Total
    United States                  $       313.8        75%   $       462.2        72%
    Europe1                                 41.2        10%            77.8        12%
    Asia-Pacific2                           35.9         9%            55.9         9%
    Canada                                  25.3         6%            47.8         7%

    Total                          $       416.2       100%   $       643.7       100%

1 Europe sales region includes Middle East and Africa.

2 Asia-Pacific sales region includes Latin America.

Components of the change in our assets under management were as follows:

                                               Three Months Ended
                                                  December 31,           Percent
         (dollar amounts in billions)           2008          2007       Change
         Beginning assets under management   $    507.3      $ 645.9       (21)%
         Sales                                     30.2         50.5       (40)%
         Redemptions                              (48.4 )      (45.9 )        5%

         Net new flows                            (18.2 )        4.6          NM
         Reinvested distributions                   7.1         19.5       (64)%

         Net flows                                (11.1 )       24.1          NM
         Distributions                             (9.0 )      (23.1 )     (61)%
         Depreciation and other                   (71.0 )       (3.2 )        NM

         Ending Assets Under Management      $    416.2      $ 643.7       (35)%

Assets under management decreased during the quarter ended December 31, 2008 as the ongoing market downturn worsened and asset values eroded, resulting in $71.0 billion of depreciation in our products. Sales activity continued to slow and redemptions remained at elevated levels during the quarter, resulting in negative net flows of $18.2 billion. The market depreciation and net outflows predominantly resulted from our equity products. During the more favorable market period of the three months ended December 31, 2007, our products experienced growth in net new flows.

Investment Management Fee Rate

For the three months ended December 31, 2008, our effective investment management fee rate (investment management fees divided by simple monthly average assets under management) decreased to 0.547% from 0.626% for the three months ended December 31, 2007. The decrease was primarily due to a shift in the mix of assets under management from equity products towards fixed-income products. This shift mainly resulted from depreciation and net outflows of equity products during the quarter. Generally, investment management fees earned on equity products are higher than fees earned on fixed-income products.