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| LM > SEC Filings for LM > Form 10-Q on 7-Nov-2008 | All Recent SEC Filings |
7-Nov-2008
Quarterly Report
Legg Mason, Inc., a holding company, with its subsidiaries (which collectively comprise "Legg Mason") is a global asset management firm. Acting through our subsidiaries, we provide investment management and related services to institutional and individual clients, company-sponsored mutual funds and other investment vehicles. We offer these products and services directly and through various financial intermediaries. We have operations principally in the United States of America and the United Kingdom and also have offices in Australia, Bahamas, Brazil, Canada, Chile, China, Dubai, France, Germany, Italy, Japan, Luxembourg, Poland, Singapore, Spain and Taiwan.
We operate in one reportable business segment, Asset Management, with three
divisions: Managed Investments, Institutional, and Wealth Management. Managed
Investments is primarily engaged in providing investment advisory services to
proprietary investment funds or to retail separately managed account programs.
Institutional focuses on providing asset management services to institutional
clients. Wealth Management is primarily focused on providing asset management
services to high net worth individuals and families and endowments and includes
our funds-of-hedge-funds business.
Our financial position and results of operations are materially affected by the overall trends and conditions of the financial markets, particularly in the United States, but increasingly in the other countries in which we operate. Results of any individual period should not be considered representative of future results. Our profitability is sensitive to a variety of factors, including, among other things, the amount and composition of our assets under management, and the volatility and general level of securities prices and interest rates. Sustained periods of unfavorable market conditions are likely to affect our profitability adversely. In addition, the diversification of services and products offered, investment performance, access to distribution channels, reputation in the market, attracting and retaining key employees and client relations are significant factors in determining whether we are successful in attracting and retaining clients. For a further discussion of factors that may affect our results of operations, refer to Item 1A. Risk Factors in our Annual Report on Form 10-K for the fiscal year ended March 31, 2008, and Part II, Item 1A in this report. Prolonged unfavorable market conditions may also impact the value of recorded intangible assets and goodwill, resulting in significant impairment losses to operating results. These matters are discussed further under the heading Critical Accounting Policies that follows.
On February 26, 2008, we announced a definitive agreement in which Citigroup Global Markets Inc., an affiliate of Citigroup, would acquire a majority of the separately managed account overlay and implementation business of our subsidiary Legg Mason Private Portfolio Group ("LMPPG"). The sale closed on April 1, 2008 and cash proceeds of approximately $181 million were received. The net gain on the sale was not material.
Terms such as "we," "us," "our," and "company" refer to Legg Mason.
The global credit and equity markets both suffered from historic and
unprecedented challenges during the six months ended September 30, 2008.
Persistent illiquidity in the credit markets and the continued decline of
investor confidence in equity markets affected all market participants. In the
three months ended September 30, 2008, the S&P 5001 and the NASDAQ Composite
Index2 each decreased 9% and the Dow Jones Industrial Average3 decreased 4%. In
the six months ended September 30, 2008, the Dow Jones Industrial Average and
S&P 500 each decreased 12% and the NASDAQ Composite Index decreased 8%. In
addition, the Federal Funds rate remained at 2.00%, down from 2.25% at March 31,
2008. On October 8, 2008 and October 29, 2008, the Federal Reserve Board
reduced the rate by 0.5% each to the current 1.0%. Like many of our competitors
in the asset management industry, these market pressures resulted in a
significant reduction in our assets under management ("AUM"), and accordingly,
in our revenues and net income. The challenging markets persisted into the
December quarter with the NASDAQ Composite Index, S&P 500, and Dow Jones
Industrial Average decreasing 18%, 17%, and 14% through October 31, 2008,
respectively.
Quarter Ended September 30, 2008 Compared to Quarter Ended September 30, 2007
Assets Under Management
The component changes in our AUM (in billions) for the three months ended
September 30 were as follows:
2008 2007
Beginning of period $ 922.8 $ 992.4
Net client cash flows (20.0) 0.3
Market performance and other (60.9) 18.9
End of period $ 841.9 $ 1,011.6
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AUM at September 30, 2008, was $841.9 billion, down $169.7 billion, or 17%, from September 30, 2007. Market conditions accounted for $102.6 billion, or 60% of the total change in AUM. Net client cash outflows accounted for $66.7 billion, or 39% of the decrease, and were driven by outflows in equity assets of approximately $48 billion and fixed income outflows of $28 billion. We have experienced net equity outflows in each quarter since the September 2006 quarter. We generally earn higher fees and profits on equity AUM, and outflows in this asset class will more negatively impact our revenues and net income than would outflows from other asset classes. These flows were offset in part by approximately $10 billion of liquidity inflows.
In the last three months, AUM decreased by $80.9 billion, or 9%, from $922.8 billion at September 30, 2008. Market conditions accounted for $60.9 billion, or 75% of the quarter change in AUM. Net client cash outflows of $20.0 billion accounted for 25% of the change. Net client outflows in fixed income and equity assets of approximately $12 billion and $9 billion, respectively, were minimally offset by net inflows of approximately $1 billion in liquidity assets. Equity outflows resulted in part from lower relative investment performance, particularly in some of our key equity products at ClearBridge Advisors LLC ("ClearBridge"), Legg Mason Capital Management, Inc. ("LMCM") and Private Capital Management, LP ("PCM"). Fixed income outflows resulted in part from lower relative investment performance in certain fixed income products primarily managed by Western Asset Management Company ("Western Asset").
1 S&P is a trademark of Standard & Poor's, a division of the McGraw-Hill Companies, Inc., which is not affiliated with Legg Mason.
2 NASDAQ is a trademark of the NASDAQ Stock Market, Inc., which is not affiliated with Legg Mason.
3 Dow Jones Industrial Average is a trademark of Dow Jones & Company, which is not affiliated with Legg Mason.
AUM by Asset Class
AUM by asset class (in billions) as of September 30 were as follows:
% of % of %
2008 Total 2007 Total Change
Equity $ 214.8 25.5 % $ 343.9 34.0 % (37.5) %
Fixed Income 451.8 53.7 506.0 50.0 (10.7)
Liquidity 175.3 20.8 161.7 16.0 8.4
Total $ 841.9 100.0 % $ 1,011.6 100.0 % (16.8) %
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Average AUM by asset class (in billions) for the three months ended September 30 was as follows:
% of % of %
2008 Total 2007 Total Change
Equity $ 239.9 26.7 % $ 341.6 34.3 % (29.8) %
Fixed Income 476.7 53.1 492.2 49.5 (3.1)
Liquidity 181.8 20.2 160.9 16.2 13.0
Total $ 898.4 100.0 % $ 994.7 100.0 % (9.7) %
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AUM by Division
AUM by division (in billions) as of September 30 were as follows:
% of % of %
2008 Total 2007 Total Change
Managed Investments $ 346.4 41.2 % $ 411.4 40.7 % (15.8) %
Institutional 443.3 52.6 530.3 52.4 (16.4)
Wealth Management 52.2 6.2 69.9 6.9 (25.3)
Total $ 841.9 100.0 % $ 1,011.6 100.0 % (16.8) %
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The component changes in our AUM by division (in billions) for the three months ended September 30, 2008 were as follows:
Managed Wealth
Investments Institutional Management Total
Beginning of period $ 371.6 $ 492.6 $ 58.6 $ 922.8
Net client cash flows (5.1) (12.9) (2.0) (20.0)
Market performance and other (20.1) (36.4) (4.4) (60.9)
End of period $ 346.4 $ 443.3 $ 52.2 $ 841.9
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Assets managed for U.S. domiciled clients accounted for 65% and 67% of total assets managed and non-U.S. domiciled clients represented 35% and 33% of total assets managed as of September 30, 2008 and 2007, respectively.
Revenue by Division
Operating revenues by division (in millions) for the three months ended
September 30 were as follows:
% of % of %
2008 Total 2007 Total Change
Managed Investments $ 524.0 54.3 % $ 653.5 55.7 % (19.8) %
Institutional 219.5 22.7 261.0 22.3 (15.9)
Wealth Management 222.6 23.0 257.9 22.0 (13.7)
Total $ 966.1 100.0 % $ 1,172.4 100.0 % (17.6) %
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The decrease in operating revenues in the Managed Investments division was primarily due to decreased distribution and service fee revenues from U.S. retail equity funds, decreased mutual fund revenues at LMCM and ClearBridge, and decreased separate account revenues at ClearBridge and LMPPG, as a result of the sale of the LMPPG business on April 1, 2008. These decreases were partially offset by increased mutual fund revenues at Western Asset. The decrease in operating revenues in the Institutional division was primarily due to decreased separate account revenues at LMCM and Western Asset. The decrease in operating revenues in the Wealth Management division was primarily due to decreased separate account revenues at PCM.
Results of Operations
Operating Revenues
Total operating revenues in the quarter ended September 30, 2008 were $966.1
million, down 18% from $1.17 billion in the prior year quarter, primarily as a
result of a 10% decrease in average AUM, due to a decline in average equity
assets of approximately 30% and average fixed income assets of approximately 3%,
offset in part by an increase in average liquidity assets of approximately 13%.
Operating revenues were also negatively impacted by a decline in performance
fees of approximately $20.8 million, or 86%.
Investment advisory fees from separate accounts decreased $92.9 million, or 25%, to $283.1 million, primarily as a result of lower average equity assets managed by PCM, LMCM, and ClearBridge, a reduction in advisory fees due to the sale of the LMPPG business, and lower average fixed income assets managed by Western Asset.
Investment advisory fees from funds decreased 8% to $540.8 million, primarily as a result of lower average equity assets managed by LMCM and ClearBridge, offset in part by an increase in average liquidity assets managed by Western Asset.
Performance fees decreased 86% to $3.4 million, as a result of lower performance fees earned by Permal Group Ltd ("Permal"), Royce & Associates LLC ("Royce") and Brandywine Global Investment Management, LLC ("Brandywine").
Distribution and service fee revenues decreased 23% to $135.8 million, primarily as a result of a decline in average AUM of the retail share classes of our domestic equity funds.
Operating Expenses
Compensation and benefits decreased 25% to $322.2 million. This decrease was primarily driven by a reduction in revenue-share based incentive compensation expense, related to lower revenues in the current quarter, a decrease in deferred compensation obligations resulting from
Distribution and servicing expenses decreased 13% to $279.0 million primarily as a result of a decrease in average AUM in certain products for which we pay fees to third-party distributors.
Communications and technology expense increased 3% to $49.1 million, primarily as a result of increased depreciation expense and other expenditures related to investment management infrastructure, offset in part by a decrease in consulting fees.
Occupancy expense increased 7% to $33.8 million, primarily due to increased depreciation expense on furniture and leasehold improvements and increased rent expense. These increases were offset in part by reduced rent in the current year quarter resulting from a new sublease agreement.
Amortization of intangible assets decreased 33% to $9.6 million, primarily as a result of the sale of the LMPPG business and the impact of the write-down of an intangible asset in the fourth quarter of fiscal 2008.
Other expenses increased 7% to $52.3 million, primarily as a result of foreign currency losses and a trading error, offset in part by a decrease in conferences and travel expenses.
Interest income increased 16% to $21.0 million, primarily as a result of an increase in average investment account balances, offset in part by a decline in average interest rates earned on these balances.
Interest expense increased 127% to $37.8 million, due to $1.15 billion of
additional debt issued as part of the Equity Units in the quarter ended June 30,
2008, the issuance of $1.25 billion of convertible senior notes during the
fourth quarter of fiscal 2008, and $500 million of borrowings under our $1.0
billion unsecured revolving credit facility in the third quarter of fiscal 2008.
These increases were offset in part by the impact of the repayment of $425
million principal amount of 6.75% senior notes in the current quarter and a
borrowing rate reduction on our $700 million term loan.
Other non-operating income (expense) decreased $367.5 million to a loss of $363.3 million. This decrease was primarily driven by unrealized losses and other costs related to liquidity fund support of approximately $324.6 million. See Note 10 of Notes to Consolidated Financial Statements for additional information. Unrealized market losses on assets held in deferred compensation plans and proprietary fund products also contributed to the decrease.
The income tax benefit was $55.8 million, primarily as a result of lower earnings due to losses related to liquidity fund support. The effective tax rate was 34.9% in the current year period, compared to 37.5% in the prior year period, primarily due to the impact of relatively lower state
Net loss for the three months ended September 30, 2008 totaled $103.8 million,
or $0.74 per diluted share, a decrease from net income of $177.5 million, or
$1.23 per diluted share, in the prior year's quarter. Cash income (loss) (see
Supplemental Non-GAAP Financial Information) declined for the quarter ended
September 30, 2008 to ($54.0) million, or ($0.38) per diluted share, from cash
income of $231.8 million, or $1.60 per diluted share, in the prior year quarter.
These decreases were due to net losses related to liquidity fund support, net
of income tax benefits and operating expense adjustments, of $191.1 million, or
$1.35 per diluted share, as well as an overall reduction in operating revenues
due to a 10% decrease in average AUM and reduced performance fees. The pre-tax
profit margin decreased to (16.5%) from 24.2% in the prior year period. The
pre-tax profit margin, as adjusted (see Supplemental Non-GAAP Financial
Information), for the quarters ended September 30, 2008 and 2007 was (23.3%) and
33.4%, respectively. During the quarter ended September 30, 2008, losses
related to liquidity fund support reduced the pre-tax profit margin by 32.0
percentage points and the pre-tax profit margin, as adjusted, by 45.1 percentage
points.
Six Months Ended September 30, 2008 Compared to Six Months Ended September 30, 2007
Assets Under Management
The component changes in our AUM (in billions) for the six months ended
September 30 were as follows:
2008 2007
Beginning of period $ 950.1 $ 968.5
Net client cash flows (38.5) 1.9
Market performance and other (69.2) 42.5
Acquisitions (dispositions), net (0.5) (1.3)
End of period $ 841.9 $ 1,011.6
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In the last six months, AUM decreased by $108.2 billion, or 11%, from $950.1 billion at March 31, 2008, driven by a reduction of $69.2 billion from market performance and $38.5 billion of net client cash outflows. Net client outflows in fixed income and equity assets of approximately $23 billion and $20 billion, respectively, were offset in part by net inflows of approximately $5 billion in liquidity assets. Equity outflows resulted in part from lower relative investment performance, particularly in some of our key equity products at ClearBridge, LMCM and PCM. Fixed income outflows resulted in part from lower relative investment performance in certain fixed income products primarily managed by Western Asset.
AUM by Asset Class
Average AUM by asset class (in billions) for the six months ended September 30
were as follows:
% of % of %
2008 Total 2007 Total Change
Equity $ 255.7 27.7 % $ 344.5 34.8 % (25.8) %
Fixed Income 489.3 53.0 484.7 49.0 0.9
Liquidity 178.6 19.3 160.2 16.2 11.5
Total $ 923.6 100.0 % $ 989.4 100.0 % (6.7) %
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Managed Wealth
Investments Institutional Management Total
Beginning of period $ 376.6 $ 511.4 $ 62.1 $ 950.1
Net client cash flows (8.2) (25.6) (4.7) (38.5)
Market performance and other (22.0) (42.5) (5.2) (69.7)
End of period $ 346.4 $ 443.3 $ 52.2 $ 841.9
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Revenue by Division
Operating revenues by division (in millions) for the six months ended September
30 were as follows:
% of % of %
2008 Total 2007 Total Change
Managed Investments $ 1,095.5 54.2 % $ 1,322.8 55.6 % (17.2) %
Institutional 462.5 22.9 520.8 21.9 (11.2)
Wealth Management 462.2 22.9 534.7 22.5 (13.6)
Total $ 2,020.2 100.0 % $ 2,378.3 100.0 % (15.1) %
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The decrease in operating revenues in the Managed Investments division was primarily due to decreased distribution and service fee revenues from U.S. retail equity funds, decreased mutual fund revenues at LMCM and ClearBridge, and decreased separate account revenues at ClearBridge and LMPPG, as a result of the sale of the LMPPG business on April 1, 2008. These decreases were partially offset by increased mutual fund revenues at Western Asset. The decrease in operating revenues in the Institutional division was primarily due to decreased separate account revenues at LMCM and decreased performance fees at Legg Mason International Equities ("LMIE"). The decrease in operating revenues in the Wealth Management division was primarily due to decreased separate account revenues at PCM and decreased performance fees at Permal, partially offset by increased fund revenues at Permal.
Results of Operations
Operating Revenues
Total operating revenues in the six months ended September 30, 2008 were $2.0
billion, down 15% from $2.4 billion in the prior year, primarily as a result of
a 7% decrease in average AUM, due to a decline in average equity assets of
approximately 26%, offset in part by an increase in average liquidity assets of
approximately 11% and a slight increase in average fixed income assets.
Operating revenues were also negatively impacted by a decline in performance
fees of approximately $65.1 million, or 83%.
Investment advisory fees from separate accounts decreased $157.2 million, or 21%, to $599.8 million, primarily as a result of lower average equity assets managed by PCM, LMCM, and ClearBridge and a reduction in advisory fees due to the sale of the LMPPG business.
Investment advisory fees from funds decreased 5% to $1.1 billion, primarily as a result of lower average equity assets managed by LMCM and ClearBridge, offset in part by an increase in average liquidity assets managed by Western Asset and average assets managed by Permal.
Distribution and service fee revenues decreased 20% to $289.3 million, primarily as a result of a decline in average AUM of the retail share classes of our domestic and international equity funds.
Operating Expenses
Compensation and benefits decreased 20% to $699.9 million. This decrease was
primarily driven by a reduction in revenue-share based incentive compensation
expense, related to lower revenues in the six months ended September 30, 2008, a
decrease related to charges to provide support for liquidity funds and market
losses on assets held in deferred compensation plans. See Note 10 of Notes to
Consolidated Financial Statements for further discussion of the liquidity fund
support. Compensation as a percentage of operating revenues decreased to 34.6%
in the current year period from 36.8% in the prior year period, primarily as a
result of a decrease in compensation related to liquidity fund support, and
compensation reductions related to unrealized market losses on assets held in
deferred compensation plans which were partially offset by fixed compensation
costs of administrative and sales personnel which do not vary with revenues.
The unrealized losses on the liquidity fund support are included in Other
non-operating income (expense).
Distribution and servicing expenses decreased 9% to $586.8 million primarily as a result of a decrease in average AUM in certain products for which we pay fees to third-party distributors, offset in part by an increase in average assets managed by Permal.
Communications and technology expense increased 4% to $99.4 million, primarily as a result of increased depreciation expense and other expenditures related to investment management infrastructure, offset in part by a decrease in consulting fees.
Occupancy expense increased 9% to $67.9 million, primarily as a result of increased depreciation on furniture and leasehold improvements, higher rent at new office locations, and the recognition of a loss related to a new sublease arrangement during the six months ended September 30, 2008, which were offset in part by reduced rent in the current year period due to the previously mentioned sublease agreement.
Amortization of intangible assets decreased 35% to $19.2 million, primarily as a result of the sale of the LMPPG business and the impact of the write-down of an intangible asset in the fourth quarter of fiscal 2008.
Other expenses decreased 4% to $97.8 million, primarily as a result of a decrease in professional fees and reduced promotional expenses, which were offset in part by foreign currency losses.
Interest income increased 28% to $44.3 million, primarily as a result of an increase in average investment account balances due to proceeds from the issuance of debt, offset in part by a decline in average interest rates earned on these balances.
Interest expense increased 120% to $74.4 million, due to debt issued in May 2008, as part of the Equity Units, and the 2.5% convertible senior notes issued in January 2008, and $500 million of borrowings under our $1.0 billion unsecured revolving credit facility in the third quarter of fiscal 2008. These increases were offset in part by the impact of the repayment of $425 million
Other non-operating income (expense) decreased $647.2 million to a loss of $628.9 million. This decrease was primarily driven by unrealized losses and other costs related to liquidity fund support of approximately $591.5 million. See Note 10 of Notes to Consolidated Financial Statements for further discussion of the liquidity fund support. Unrealized market losses on assets held in deferred compensation plans and proprietary fund products also contributed to the decrease.
The income tax benefit was $74.5 million, primarily as a result of lower earnings due to losses related to liquidity fund support. The effective tax rate was 35.5% in the current year period compared to 37.5% in the prior year period, . . .
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