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| LM > SEC Filings for LM > Form 10-Q on 9-Feb-2009 | All Recent SEC Filings |
9-Feb-2009
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, such as the period we have experienced over the past year, 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 sharp decline in equity markets and continuing dislocations in the credit markets adversely affected the entire financial sector during the quarter. The equity markets suffered from pullback in consumer spending, which led to weak performance, increased unemployment, and major write downs by financial institutions. Investors' confidence continued to weaken during the December quarter, which caused a shift in the markets from equity to US treasury notes and bonds. In the three months ended December 31, 2008, the NASDAQ Composite Index1 decreased 24%, the S&P 5002 decreased 22%, and the Dow Jones Industrial Average3 decreased 19%. In the nine months ended December 31, 2008, the S&P 500 and the NASDAQ Composite Index each decreased 32%, and the Dow Jones Industrial Average decreased 28%. In the three months ended December 31, 2008, the Barclays Capital U.S. Aggregate Bond Index4 and the Barclays Capital Global Aggregate Bond Index4 each increased 5%. In the nine months ended December 31, 2008, the Barclays Capital U.S. Aggregate Bond Index increased 3% and the Barclays Capital Global Aggregate Bond Index decreased 2%. During the December quarter, the Federal Reserve Board reduced the discount rate by 1.75% to the current rate of 0.25%. These market pressures contributed to a significant erosion in our assets under management ("AUM") from net client outflows and market depreciation and, accordingly, in our revenues and net income. The challenging markets continued into the March quarter with the S&P 500 and Dow Jones Industrial Average each decreasing 9% and the NASDAQ Composite Index decreasing 6% through January 31, 2009. The Barclays Capital Global Aggregate Bond Index and Barclays Capital U.S. Aggregate Bond Index decreased 3% and 1%, respectively, through January 31, 2009. During the month of January, we estimate that our AUM declined approximately 5% from December 31, 2008, as a result of negative equity and fixed income market performance and client outflows. These outflows represent a significant improvement from December quarter outflow levels.
Quarter Ended December 31, 2008 Compared to Quarter Ended December 31, 2007
Assets Under Management
The component changes in our AUM (in billions) for the three months ended
December 31 were as follows:
2008 2007
Beginning of period $ 841.9 $ 1,011.6
Net client cash flows (77.0) (9.1)
Market performance (66.7) (4.0)
End of period $ 698.2 $ 998.5
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1 NASDAQ is a trademark of the NASDAQ Stock Market, Inc., which is not affiliated with Legg Mason.
2 S&P is a trademark of Standard & Poor's, a division of the McGraw-Hill Companies, 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.
4 Barclays Capital U.S. Aggregate Bond Index and Barclays Capital Global Aggregate Bond Index are trademarks of Barclays Capital, which is not affiliated with Legg Mason.
AUM by Asset Class
AUM by asset class (in billions) as of December 31 were as follows:
% of % of %
2008 Total 2007 Total Change
Equity $ 148.4 21.3 % $ 320.8 32.1 % (53.7) %
Fixed Income 392.1 56.1 514.5 51.5 (23.8)
Liquidity 157.7 22.6 163.2 16.4 (3.4)
Total $ 698.2 100.0 % $ 998.5 100.0 % (30.1) %
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The component changes in our AUM by asset class (in billions) for the three months ended December 31, 2008 were as follows:
Equity Fixed Income Liquidity Total
Beginning of period $ 214.8 $ 451.8 $ 175.3 $ 841.9
Net client cash flows (17.4) (42.0) (17.6) (77.0)
Market performance (49.0) (17.7) - (66.7)
End of period $ 148.4 $ 392.1 $ 157.7 $ 698.2
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Average AUM by asset class (in billions) for the three months ended December 31 was as follows:
% of % of %
2008 Total 2007 Total Change
Equity $ 169.6 22.8 % $ 335.6 33.1 % (49.5) %
Fixed Income 408.3 54.8 512.9 50.6 (20.4)
Liquidity 167.2 22.4 165.2 16.3 1.2
Total $ 745.1 100.0 % $1,013.7 100.0 % (26.5) %
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AUM by Division
AUM by division (in billions) as of December 31 were as follows:
% of % of %
2008 Total 2007 Total Change
Managed Investments $ 284.5 40.7 % $ 398.8 39.9 % (28.7) %
Institutional 378.0 54.2 532.4 53.3 (29.0)
Wealth Management 35.7 5.1 67.3 6.8 (47.0)
Total $ 698.2 100.0 % $ 998.5 100.0 % (30.1) %
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Managed Wealth
Investments Institutional Management Total
Beginning of period $ 346.4 $ 443.3 $ 52.2 $ 841.9
Net client cash flows (27.7) (40.4) (8.9) (77.0)
Market performance (34.2) (24.9) (7.6) (66.7)
End of period $ 284.5 $ 378.0 $ 35.7 $ 698.2
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AUM at December 31, 2008, was $698.2 billion, down $300.3 billion, or 30%, from December 31, 2007. Market performance accounted for $164.5 billion, or 55% of the total change in AUM. Net client cash outflows accounted for $134.6 billion, or 45% of the decrease, and were driven by outflows in fixed income assets of approximately $72 billion and equity outflows of $55 billion. We have experienced net equity outflows in each quarter since the September 2006 quarter and net fixed income outflows for the last four quarters. 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 in other asset classes. Liquidity outflows were $8 billion during this period.
In the last three months, AUM decreased by $143.7 billion, or 17%, from $841.9 billion at September 30, 2008. Net client cash outflows accounted for $77.0 billion, or 54% of the quarter change in AUM. Market performance had a negative impact of $66.7 billion, accounting for 46% of the change. There were net client outflows in all asset classes, with fixed income outflows of approximately $42.0 billion, and equity and liquidity asset outflows of approximately $17.4 billion and $17.6 billion, respectively. Equity outflows resulted in part from lower relative investment performance, particularly in some of our key equity products managed by 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"). Permal Group Ltd ("Permal") also experienced outflows during the quarter.
Assets managed for U.S. domiciled clients accounted for 65% and 66% of total assets managed and non-U.S. domiciled clients represented 35% and 34% of total assets managed as of December 31, 2008 and 2007, respectively.
Revenue by Division
Operating revenues by division (in millions) for the three months ended December
31 were as follows:
% of % of %
2008 Total 2007 Total Change
Managed Investments $ 385.9 53.6 % $ 634.4 53.5 % (39.2) %
Institutional 179.5 24.9 255.5 21.5 (29.7)
Wealth Management 154.6 21.5 296.7 25.0 (47.9)
Total $ 720.0 100.0 % $ 1,186.6 100.0 % (39.3) %
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Results of Operations
Operating Revenues
Total operating revenues in the quarter ended December 31, 2008 were $720.0 million, down 39% from $1.19 billion in the prior year quarter, primarily as a result of a 26% decrease in average AUM, due to a decline in average equity assets of approximately 49% and average fixed income assets of approximately 20%, offset in part by a slight increase in average liquidity assets. Operating revenues were also negatively impacted by a decline in performance fees of approximately $47.9 million, or 94%, primarily at Permal.
Investment advisory fees from separate accounts decreased $140.6 million, or 38%, to $225.2 million. Of this decrease, approximately $98 million was the result of lower average equity assets managed, primarily at PCM, LMCM, ClearBridge and Brandywine, approximately $35 million was the result of lower average fixed income assets managed at Western, and approximately $12 million was the result of the sale of the LMPPG business.
Investment advisory fees from funds decreased $204.0 million, or 34%, to $389.4 million. Of this decrease approximately $182 million was the result of lower average equity assets managed, primarily at Permal, LMCM, ClearBridge and Royce, approximately $35 million was the result of lower average fixed income assets managed, primarily at Western Asset and Permal, offset by approximately $13 million which was the result of increased liquidity assets managed, primarily at Western Asset.
Performance fees decreased 94% to $2.9 million, as a result of lower performance fees earned by Permal.
Distribution and service fee revenues decreased 42% to $100.0 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 47% to $195.2 million. This decrease was primarily driven by an approximate $127.6 million reduction in revenue-share based incentive compensation related to lower revenues in the current quarter, an approximate $30.8 million decrease in deferred compensation obligations resulting from market losses on invested assets in deferred compensation plans, which is offset in other non-operating income, an approximate $32.1 million reduction in incentive compensation for administrative and sales personnel, and an approximate $21.6 million decrease in profit sharing benefits. Compensation as a percentage of operating revenues decreased to 27.1% in the current quarter from 30.9% in the prior year quarter, primarily as a result of the incentive compensation reductions for administrative and sales personnel, reduced profit sharing benefits, and unrealized market losses on assets held in deferred compensation plans.
Distribution and servicing expenses decreased 38% to $202.5 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 decreased 1% to $45.1 million, primarily as a result of an approximate $0.5 million decrease in consulting fees.
Occupancy expense increased 106% to $70.7 million, primarily due to a $36.1 million charge resulting from the default on a sublease agreement we have with a sub-tenant.
Amortization of intangible assets decreased 35% to $9.3 million, primarily as a result of the sale of the LMPPG business and the impact of the write-down of management contracts in the fourth quarter of fiscal 2008, which together reduced amortization expense by approximately $4.0 million.
Impairment charges were $1.2 billion in the December quarter, representing the write-down of goodwill and intangible assets in the Wealth Management division as a result of declines in the AUM and projected cash flows of Wealth Management affiliates. See Note 5 of Notes to Consolidated Financial Statements for further discussion of the impairment of goodwill and intangible assets.
Other expenses decreased 22% to $45.1 million, primarily as a result of an approximate $6.1 million decrease in travel and promotional expenses and the favorable impact of foreign currency gains of approximately $4.5 million.
Interest income decreased 56% to $8.5 million, primarily due to a decline in average interest rates earned on investment account balances, which resulted in an approximate $15 million decrease, offset in part by higher average investment account balances due to proceeds from the issuance of debt, which resulted in an approximate $4 million increase.
Interest expense increased 80% to $37.5 million, due to $1.15 billion of additional debt issued as part of the Equity Units in the quarter ended June 30, 2008 and the issuance of $1.25 billion of convertible senior notes during the fourth quarter of fiscal 2008, which resulted in an increase of approximately $23.7 million. These increases were offset in part by the impact of the repayment of $425 million principal amount of 6.75% senior notes in the quarter ended September 30, 2008, and lower interest rates paid on our term loan and revolving credit facility, which together resulted in a decrease of approximately $11.3 million.
Fund support losses increased by $994.8 million to $1.09 billion, largely due to a $842.1 million realized loss on the sale of securities issued by Axon Financial ("Axon"), and $243.2 million of losses recognized during the current year quarter as a result of additional support for liquidity funds and reduced values on previously supported securities. See Note 10 of Notes to Consolidated Financial Statements for additional information.
Other non-operating expense increased $72.6 million to $75.6 million. This increase was primarily driven by an increase of $34.5 million and $21.4 million in unrealized market losses on assets held in deferred compensation plans and proprietary fund products, respectively.
The income tax benefit was $775.0 million compared to income tax expense of $92.3 million in the prior period, primarily as a result of the loss due to the impairment of goodwill and intangible assets and losses related to liquidity fund support. The effective tax rate declined to 34.2% in the
Net loss for the three months ended December 31, 2008 totaled $1.49 billion, or $10.55 per diluted share, a decrease from net income of $154.6 million, or $1.07 per diluted share, in the prior year's quarter. Cash loss (see Supplemental Non-GAAP Financial Information) declined for the quarter ended December 31, 2008 to $1.82 billion, or $12.88 per diluted share, from cash income of $205.1 million, or $1.42 per diluted share, in the prior year quarter. These decreases were primarily due to a charge of $1.23 billion ($850.7 million, net of tax or $6.03 per diluted share), related to the impairment of goodwill and intangible assets in our Wealth Management division and an increase in losses, net of income tax benefits and operating expense adjustments, of $639.8 million, or $4.54 per diluted share, related to liquidity fund support, largely the result of the sale of securities issued by Axon. The pre-tax profit margin decreased to (314.3%) from 20.8% in the prior year period. The pre-tax profit margin, as adjusted (see Supplemental Non-GAAP Financial Information), for the quarters ended December 31, 2008 and 2007 was (437.3%) and 28.7%, respectively. During the quarter ended December 31, 2008, losses related to the impairment charges and liquidity fund support reduced the pre-tax profit margin by 170.2 percentage points and 148.6 percentage points, respectively, and the pre-tax profit margin, as adjusted, by 236.8 percentage points and 206.8 percentage points, respectively. During the quarter ended December 31, 2007, losses related to liquidity fund support reduced the pre-tax profit margin and pre-tax profit margin, as adjusted, by 3.1 and 4.2 percentage points, respectively.
Nine Months Ended December 31, 2008 Compared to Nine Months Ended December 31, 2007
Assets Under Management
The component changes in our AUM (in billions) for the nine months ended
December 31 were as follows:
2008 2007
Beginning of period $ 950.1 $ 968.5
Net client cash flows (115.4) (7.2)
Market performance (136.0) 38.5
Acquisitions (dispositions), net (0.5) (1.3)
End of period $ 698.2 $ 998.5
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AUM by Asset Class
Average AUM by asset class (in billions) for the nine months ended December 31
were as follows:
% of % of %
2008 Total 2007 Total Change
Equity $ 225.3 26.2 % $ 341.0 34.2 % (33.9) %
Fixed Income 460.6 53.5 493.9 49.5 (6.7)
Liquidity 174.4 20.3 162.0 16.3 7.7
Total $ 860.3 100.0 % $ 996.9 100.0 % (13.7) %
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Equity Fixed Income Liquidity Total
Beginning of period $ 271.6 $ 508.2 $ 170.3 $ 950.1
Net client cash flows (37.7) (64.9) (12.8) (115.4)
Market performance (85.0) (51.2) 0.2 (136.0)
Acquisitions (dispositions), net (0.5) - - (0.5)
End of period $ 148.4 $ 392.1 $ 157.7 $ 698.2
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AUM by Division
The component changes in our AUM by division (in billions) for the nine months
ended December 31, 2008 were as follows:
Managed Wealth
Investments Institutional Management Total
Beginning of period $ 376.6 $ 511.4 $ 62.1 $ 950.1
Net client cash flows (35.9) (65.9) (13.6) (115.4)
Market performance (55.7) (67.5) (12.8) (136.0)
Acquisitions (dispositions), net (0.5) - - (0.5)
End of period $ 284.5 $ 378.0 $ 35.7 $ 698.2
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In the last nine months, AUM decreased by $251.9 billion, or 27%, from $950.1 billion at March 31, 2008, driven by a reduction of $136.0 billion from market performance and $115.4 billion of net client cash outflows. Net client outflows in fixed income and equity assets of approximately $64.9 billion and $37.7 billion, respectively, account for 89% of total net client flows. Liquidity outflows were approximately $12.8 billion. Equity outflows resulted in part from lower relative investment performance, particularly in some of our key equity products managed by 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.
Revenue by Division
Operating revenues by division (in millions) for the nine months ended December
31 were as follows:
% of % of %
2008 Total 2007 Total Change
Managed Investments $ 1,481.4 54.1 % $ 1,957.3 54.9 % (24.3) %
Institutional 642.0 23.4 776.3 21.8 (17.3)
Wealth Management 616.8 22.5 831.4 23.3 (25.8)
Total $ 2,740.2 100.0 % $ 3,565.0 100.0 % (23.1) %
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The decrease in operating revenues in the Managed Investments division was primarily due to decreased mutual fund revenues at LMCM, ClearBridge and Royce, decreased separate account revenues at ClearBridge and LMPPG, as a result of the sale of the LMPPG business on April 1, 2008, and decreased distribution and service fee revenues from U.S. retail equity funds. The decrease in operating revenues in the Institutional division was primarily due to decreased separate account revenues at LMCM, Western Asset and Brandywine. The decrease in operating
Results of Operations
Operating Revenues
Total operating revenues in the nine months ended December 31, 2008 were $2.7 billion, down 23% from $3.6 billion in the prior year, primarily as a result of a 14% decrease in average AUM, due to a decline in average equity assets of approximately 34% and average fixed income assets of approximately 7%, offset in part by an increase in average liquidity assets of approximately 8%. Operating revenues were also negatively impacted by a decline in performance fees of approximately $113.0 million, or 87%.
Investment advisory fees from separate accounts decreased $297.8 million, or 27%, to $824.9 million. Of this decrease, approximately $232 million was the result of lower average equity assets managed, primarily at ClearBridge, PCM, LMCM and Brandywine, approximately $35 million was the result of lower average fixed income assets managed at Western Asset, and $33.0 million was the result of the sale of the LMPPG business.
Investment advisory fees from funds decreased $261.7 million, or 15%, to $1.5 billion. Of this decrease approximately $298 million was the result of lower average equity assets managed, primarily at LMCM, ClearBridge, Permal and Royce, approximately $10 million was the result of lower average fixed income assets managed, primarily at Western Asset, offset by approximately $46 million which was the result of increased liquidity assets managed, primarily at Western Asset.
Performance fees decreased 87% to $16.5 million, primarily as a result of lower performance fees earned by Permal, Royce and Legg Mason International Equities.
Distribution and service fee revenues decreased 27% to $389.3 million, primarily . . .
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