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 two divisions or operating segments: Americas and International, which are primarily based on the geographic location of the advisor or the domicile of the fund families we manage. The Americas Division consists of our U.S.-domiciled fund families, the separate account business of our U.S.-based investment affiliates and the U.S. distribution organization. Similarly, the International Division consists of our fund complexes, distribution teams and investment affiliates located outside the U.S.

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, 2009.

Certain prior year amounts have been retrospectively revised as a result of the adoption of new accounting guidance relating to financial statement presentation of noncontrolling interests and debt with conversion and other options. See Note 2 of Notes to Consolidated Financial Statements for more information on the adoption of new accounting guidance.

Terms such as "we," "us," "our," and "company" refer to Legg Mason.

The financial environment in the United States continued to show further signs of improvement during the quarter ended September 30, 2009. During the quarter, equity markets rose as a result of slowing growth in unemployment rates, although still at elevated levels, stabilization of the financial sector, and improved consumer confidence and earnings across most industries. As a result, all three major U.S. equity market indices increased sharply during the quarter ended September 30, 2009. In the three months ended September 30, 2009, the NASDAQ Composite Index1 increased 16%, and the S&P 5002 and Dow Jones Industrial Average3 each increased 15%. In the six months ended September 30, 2009, the NASDAQ Composite Index, S&P 500, and Dow Jones Industrial Average increased 39%, 32%, and 28%, respectively. The Barclays Capital Global Aggregate Bond Index4 and the Barclays Capital U.S. Aggregate Bond Index4 also increased 6% and 4%, respectively, during the quarter ended September 30, 2009 and increased 11% and 6%, respectively, during the six months ended September 30, 2009. During the quarter, the Federal Funds rate remained at 0.25%. However, despite recent improvements, the financial environment in which we operate continues to be challenging, and we expect the challenges presented by high unemployment and troubles in the real estate and credit markets to persist throughout the rest of the fiscal year. We cannot predict how these uncertainties will impact the Company's results.

Quarter Ended September 30, 2009 Compared to Quarter Ended September 30, 2008


Assets Under Management

The components of the changes in our assets under management ("AUM") (in
billions) for the three months ended September 30 were as follows:

                                                        2009     2008
           Beginning of period                         $ 656.9  $ 922.8
           Investment funds, excluding liquidity funds
           Sales                                           9.7     15.4
           Redemptions                                   (8.8)   (21.0)
           Separate account flows, net                  (11.4)   (17.5)
           Liquidity fund flows, net                       2.4      3.1
           Net client cash flows                         (8.1)   (20.0)
           Market performance and other (1)               53.9   (60.9)
           End of period                               $ 702.7  $ 841.9

Includes impact of foreign exchange

In the last three months, AUM increased by $45.8 billion or 7.0% from $656.9 billion at June 30, 2009 to $702.7 billion at September 30, 2009. The increase in AUM was attributable to market appreciation of $54 billion, of which approximately 9% resulted from the impact of foreign currency exchange fluctuation, which was partially offset by net client outflows of $8 billion. Net client outflows improved 73% compared to the quarter ended June 30, 2009 and improvements were seen in all asset classes. The majority of outflows were from fixed income with $10 billion, or 80% of the outflows, followed by equity outflows of $2 billion. Liquidity

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.

For the quarter ended September 30, 2009, Permal experienced gross redemptions of approximately $1.2 billion, of which $1.0 billion were anticipated at the end of the June 2009 quarter due to their requirement for 95 days prior written notice of redemptions. These redemptions were substantially offset by $1.0 billion of subscriptions during the current quarter. During the quarter, Permal reduced, from 95 days to 35 days, the requirement for prior written notice of redemptions. It is expected that by January 2010 Permal will return to a redemption notice period of 20 days.

AUM at September 30, 2009 were $702.7 billion, a decrease of $139.2 billion or 16.5% from September 30, 2008. The decrease in AUM was attributable to net client outflows of $159 billion, partially offset by market appreciation of $20 billion, of which approximately 42% resulted from the impact of foreign currency exchange fluctuation. There were net client outflows in all asset classes. The majority of outflows were in fixed income with $98 billion, or 62% of the outflows, followed by equity outflows and liquidity outflows of $35 billion and $26 billion, respectively. The majority of fixed income outflows were in products managed by Western Asset that had experienced investment underperformance. Equity outflows were primarily experienced by products managed at ClearBridge, LMCM and Permal. Due in part to investment underperformance, we have experienced net equity outflows since fiscal 2007. 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. In addition, we have experienced outflows in our fixed income asset class for the past several quarters. While net outflows in the equity and fixed income areas have continued we have experienced improved net flows in all asset classes over the last four quarters.

AUM by Asset Class


AUM by asset class (in billions) as of September 30 was as follows:



                                     % of             % of       %
                             2009    Total    2008    Total   Change
              Equity       $  165.6  23.6 % $  214.8  25.5 %  (22.9) %
              Fixed Income    385.7    54.9    451.8    53.7    (14.6)
              Liquidity       151.4    21.5    175.3    20.8    (13.6)
              Total        $  702.7 100.0 % $  841.9 100.0 %  (16.5) %

                                                        Fixed
                                               Equity  Income  Liquidity  Total
   June 30, 2009                               $ 143.6 $ 366.6   $ 146.7 $ 656.9
   Investment funds, excluding liquidity funds
   Sales                                           4.8     4.9         -     9.7
   Redemptions                                   (5.5)   (3.3)         -   (8.8)
   Separate account flows, net                   (1.8)  (11.3)       1.7  (11.4)
   Liquidity fund flows, net                         -       -       2.4     2.4
   Net client cash flows                         (2.5)   (9.7)       4.1   (8.1)
   Market performance                             24.5    28.8       0.6    53.9
   September 30, 2009                          $ 165.6 $ 385.7   $ 151.4 $ 702.7

Average AUM by asset class (in billions) for the three months ended September 30 was as follows:

                                     % of             % of       %
                             2009    Total    2008    Total   Change
              Equity       $  155.7  22.8 % $  239.9  26.7 % (35.1)  %
              Fixed Income    377.5    55.2    476.7    53.1    (20.8)
              Liquidity       150.8    22.0    181.8    20.2    (17.1)
              Total        $  684.0 100.0 % $  898.4 100.0 % (23.9)  %

AUM by Division

AUM by division (in billions) as of September 30 was as follows:


                                      % of             % of      %
                              2009    Total    2008    Total   Change
               Americas      $ 484.3  68.9 % $  591.5  70.3 % (18.1) %
               International   218.4    31.1    250.4    29.7   (12.8)
               Total         $ 702.7 100.0 % $  841.9 100.0 % (16.5) %

The component changes in our AUM by division (in billions) for the three months ended September 30, 2009 was as follows:

                                                Americas International  Total
    June 30, 2009                               $  457.1      $  199.8 $  656.9
    Investment funds, excluding liquidity funds
    Sales                                            5.9           3.8      9.7
    Redemptions                                    (6.0)         (2.8)    (8.8)
    Separate account flows, net                    (7.2)         (4.2)   (11.4)
    Liquidity fund flows, net                      (4.5)           6.9      2.4
    Net client cash flows                         (11.8)           3.7    (8.1)
    Market performance and other                    39.0          14.9     53.9
    September 30, 2009                           $ 484.3       $ 218.4  $ 702.7

Investment Performance(5)

Investment performance in the quarter ended September 30, 2009 continued to improve relative to respective benchmarks from the previous quarter. Optimism seemed to dominate the markets as improved economic data further supported expectations of a global economic recovery throughout the quarter. Despite this optimism, the prolonged high jobless rate weighed heavily on investors and policy makers. As of September 30, 2009, for the trailing 1-year, 3-year, 5-year, and 10-year periods approximately 77%, 60%, 71%, and 92%, respectively, of our marketed equity composite(6) assets outpaced their benchmarks. As of September 30, 2008, for the trailing 1-year, 3-year, 5-year, and 10-year periods approximately 43%, 43%, 44%, and 95%, respectively, of our marketed equity composite assets outpaced their benchmarks.

In the fixed income markets, government yields decreased during the quarter as demand continued to be strong overseas and was supported by the Federal Reserve purchase program. With the return of an appetite for risk and credit conditions improving, many sector spreads narrowed, most notably investment-grade and high-yield credit.

The Treasury yield curve flattened from last quarter with the 30-year yield declining 0.28%. The best performing major fixed income sector was high yield as measured by the Barclays U.S. High Yield returning 14.22% and the worst performing fixed income sector was Government bonds as measured by the Barclays U.S. Government Bond returning 2.03%. As of September 30, 2009, for the trailing 1-year, 3-year, 5-year, and 10-year periods approximately 82%, 15%, 23%, and 78%, respectively, of our marketed fixed income composite assets outpaced their benchmarks. As of September 30, 2008, for the trailing 1-year, 3-year, 5-year, and 10-year periods approximately 5%, 11%, 18%, and 77%, respectively, of our fixed income marketed composite assets outpaced their benchmarks.

As of September 30, 2009, for the trailing 1-year, 3-year, 5-year, and 10-year periods 81%, 65%, 62%, and 81%, respectively, of our U.S. long-term mutual fund(7) assets outpaced their Lipper category average. As of September 30, 2008, for the trailing 1-year, 3-year, 5-year, and 10-year periods 45%, 49%, 56%, and 86%, respectively, of our U.S. long-term mutual fund(7) assets outpaced their Lipper category average.

As of September 30, 2009, for the trailing 1-year, 3-year, 5-year, and 10-year periods 81%, 64%, 60%, and 80%, respectively, of our U.S. equity mutual fund(7) assets outpaced their Lipper category average. As of September 30, 2008, for the trailing 1-year, 3-year, 5-year, and 10-year periods 50%, 55%, 46%, and 84%, respectively, of our U.S. equity mutual fund(7) assets outpaced their Lipper category average.

As of September 30, 2009, for the trailing 1-year, 3-year, 5-year, and 10-year periods 80%, 70%, 68%, and 86%, respectively, of our U.S. fixed income mutual fund(7) assets outpaced their Lipper category average. As of September 30, 2008, for the trailing 1-year, 3-year, 5-year, and 10-year periods 36%, 37%, 68%, and 83%, respectively, of our U.S. fixed income mutual fund(7) assets outpaced their Lipper category average.

5 Index performance in this section includes reinvestment of dividends and capital gains.

6 A composite is an aggregation of discretionary portfolios (separate accounts and investment funds) into a single group that represents a particular investment objective or strategy. Each of our asset managers has its own specific guidelines for including portfolios in its marketed composites. Assets under management that are not managed in accordance with the guidelines are not included in a composite. As of September 30, 2009 and 2008, 86% of our equity assets under management in each period, and 83% and 81%, of our fixed income assets under management, respectively, were in marketed composites.

7 Source: Lipper Inc. includes open-end, closed-end, and variable annuity funds. As of September 30, 2009 and 2008, the U.S. long-term mutual fund assets represented in the data accounted for 14% and 13%, respectively, of our total assets under management. The performance of our U.S. long-term mutual fund assets is included in the marketed composites.

Revenue by Division

Operating revenues by division (in millions) for the three months ended
September 30 were as follows:


                                       % of            % of     %
                               2009   Total    2008   Total  Change
                Americas      $ 469.6  71.2% $  645.5  66.8% (27.3)%
                International   190.3   28.8    320.6   33.2  (40.6)
                Total         $ 659.9 100.0% $  966.1 100.0% (31.7)%

The decrease in operating revenues in the Americas division was primarily due to decreased mutual fund advisory fees on assets managed by Western Asset, LMCM, and ClearBridge, decreased separate account advisory fees on assets managed by Western Asset and ClearBridge and decreased distribution and service fee revenues from U.S. retail equity and liquidity funds. The decrease in operating revenues in the International division was primarily due to decreased fund revenues at Permal.

Results of Operations

Operating Revenues

Total operating revenues in the quarter ended September 30, 2009 were $659.9 million, down 32% from $966.1 million in the prior year quarter, primarily as a result of a 24% decrease in average AUM, driven by a decline in average equity assets of 35%, fixed income assets of 21%, and liquidity assets of 17%. The shift in the mix of AUM from higher fee equity assets to a greater percentage of fixed income and liquidity assets also contributed to the revenue decline.

Investment advisory fees from separate accounts decreased $76.1 million, or 27%, to $207.0 million. Of this decrease, $38.4 million was the result of lower average equity assets at ClearBridge, Private Capital Management, LP ("PCM"), LMCM, Brandywine, and Batterymarch Financial Management, Inc. ("Batterymarch") and $33.8 million was the result of lower average fixed income assets managed at Western Asset.

Investment advisory fees from funds decreased $193.5 million, or 36%, to $347.4 million. Of this decrease, approximately $136 million was the result of lower average equity assets managed at Permal, LMCM, ClearBridge, and Royce, and approximately $33 million was the result of lower average fixed income and liquidity assets managed at Western Asset.

Performance fees increased $6.1 million to $9.6 million, primarily as a result of higher performance fees earned on assets managed by Western Asset and alternative investment products managed by Permal.

Distribution and service fees decreased $41.2 million, or 30%, to $94.6 million, primarily as a result of a decline in average AUM of the retail share classes of our domestic equity and liquidity funds and our alternative investment products, which resulted in a decrease of $32.4 million and $9.6 million, respectively.

Operating expenses in the quarter ended September 30, 2009, when compared to the quarter ended September 30, 2008, benefited from cost reduction initiatives implemented through June 2009. The discussion below for each of our operating expenses identifies the amount of variance attributable to these cost-saving initiatives, where the initiatives were a significant driver of the variance. A portion of our cost saving initiatives were realized in the September 2008 quarter and thus will not be reflected in the year-over-year cost savings-related variance, and certain costs, such as compensation and promotional expenses, have increased as a result of higher levels of revenues.

Compensation and benefits decreased 11% to $287.6 million. This decrease was primarily driven by a $56 million decrease in revenue share based compensation, primarily resulting from lower revenues in the quarter ended September 30, 2009, and the impact of cost savings initiatives such as reductions in headcount, discretionary incentives and other discretionary compensation that lowered compensation by approximately $16 million. These were offset in part by an increase in deferred compensation obligations of approximately $39 million resulting from market gains on assets invested for deferred compensation plans (which are offset by gains in other non-operating income). Compensation as a percentage of operating revenues increased to 43.6% from 33.3% in the prior year period primarily as a result of compensation increases related to unrealized market gains on assets invested for deferred compensation plans and a reduction in non-compensation operating expenses at affiliates under revenue-sharing agreements, which results in a corresponding increase in incentive compensation.
In addition, the impact of fixed compensation costs which do not vary with revenues, contributed to the increase.

Distribution and servicing expenses decreased 37% to $174.4 million 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 17% to $40.5 million, as a result of a $3.5 million reduction in printing costs, a $2.3 million reduction in technology depreciation expense, which resulted from the full depreciation of certain assets prior to the current quarter, and cost savings initiatives that contributed to a $1.9 million decrease in technology consulting fees.

Occupancy expense increased 6% to $35.7 million, primarily due to increased costs associated with the relocation to our new corporate headquarters, including approximately $1.5 million for duplicate facilities during the transition.

Amortization of intangible assets decreased 41% to $5.7 million, primarily as a result of the impact of the asset impairments during fiscal 2009, which reduced amortization expense by $3.7 million.

Other expenses decreased 27% to $38.2 million, primarily as a result of reductions in advertising and travel and entertainment costs of $3.9 million and $3.8 million, respectively, as well as $2.0 million of foreign currency gains.

As discussed above, during the quarter ended September 30, 2009, we relocated our corporate headquarters. As a result of changes in facilities utilization plans, including headcount reductions, we are currently pursuing sub-tenants for certain floors under lease. If we secure a sublease or determine the space will not be used in the future, we expect to recognize a charge, given the current commercial real estate market, of approximately $30 million for the present value of the amount by which our commitment under our lease exceeds the amount due to us

Other Non-Operating Income (Expense)

Interest income decreased 92% to $1.7 million, primarily as a result of a decline in average interest rates earned on investment balances and lower average investment balances, which reduced interest income by $15.4 million and $4.1 million, respectively.

Interest expense decreased 38% to $28.6 million, primarily as a result of a $15.2 million decrease due to the exchange of our Equity Units in the current year quarter, as well as a $3.5 million reduction due to the repayment of $250 million of outstanding borrowings under our revolving credit facility and lower interest rates paid on our term loans.

Fund support losses decreased by $330.3 million to income of $5.6 million, primarily as a result of our elimination of structured investment vehicles ("SIV") exposure in the fourth quarter of fiscal 2009. Due to continued improvement in financial markets during the three months ended September 30, 2009, and the related impact on the net asset values of supported liquidity funds, we reversed unrealized, non-cash losses recorded in fiscal 2009 of $5.5 million on liquidity fund support arrangements for our offshore funds. See Note 10 of Notes to Consolidated Financial Statements for additional information.

Other income (expense) increased $57.0 million to income of $18.3 million, primarily as a result of an increase of $44.7 million in unrealized market gains on assets held in deferred compensation plans, which are substantially offset by corresponding compensation increases discussed above, and $29.8 million in unrealized market gains on investments in proprietary fund products. These increases were offset in part by a loss related to the exchange of 91% of our Equity Units in the current period quarter of $22.0 million.

Income Tax Benefit (Expense)

The provision for income taxes was $27.7 million compared to a benefit of $58.9 million in the prior year period, primarily as a result of increased earnings due to the absence of losses related to liquidity fund support. The effective tax rate was 36.9% compared to 35.1% in the prior year period, primarily due to fund support losses in the prior year with lower state tax benefits.

Net Income (Loss) Attributable to Legg Mason, Inc.

Net income attributable to Legg Mason, Inc. for the three months ended September 30, 2009 totaled $45.8 million, or $0.30 per diluted share, compared to net loss of $108.7 million, or $0.77 per diluted share, in the prior year period. Cash income (see Supplemental Non-GAAP Financial Information) for the quarter ended September 30, 2009 totaled $94.0 million, or $0.61 per diluted share, compared to cash loss of $50.9 million, or $0.36 per diluted share, in the prior year quarter. These increases were due to losses related to liquidity fund support in the prior year quarter, net of income tax benefits, which were offset in part by an overall reduction in our operating revenues due to a 24% decline in average AUM. The pre-tax profit margin increased to 11.4% from (17.4%) in the prior year period. The pre-tax profit margin, as adjusted (see Supplemental Non-GAAP Financial Information), for the quarters ended September 30, 2009 and 2008 was 15.4% and (24.4%), respectively. During the quarter ended September 30, 2009, gains related to liquidity fund support increased the pre-tax profit margin and pre-tax profit margin, as adjusted, by 0.9 percentage points and 1.2 percentage points, respectively. During the quarter ended September 30, 2008, losses related to liquidity fund support reduced the pre-tax profit margin and the pre-tax profit margin, as adjusted, by 32.0 percentage points and 45.1 percentage points, respectively.