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LM > SEC Filings for LM > Form 10-Q on 7-Aug-2013All Recent SEC Filings

Show all filings for LEGG MASON, INC.

Form 10-Q for LEGG MASON, INC.


7-Aug-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

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 ("U.S.") and the United Kingdom ("U.K.") and also have offices in Australia, Bahamas, Brazil, Canada, Chile, China, Dubai, France, Germany, Italy, Japan, Luxembourg, Poland, Singapore, Spain, Switzerland and Taiwan. Terms such as "we," "us," "our," and "Company" refer to Legg Mason.

The financial services business in which we are engaged is extremely competitive. Our competition includes numerous global, national, regional and local asset management firms, broker-dealers and commercial banks. The industry has been impacted by continued economic uncertainty, the constant introduction of new products and services, and in prior years, by the consolidation of financial services firms through mergers and acquisitions. The industry in which we operate is also subject to extensive regulation under federal, state, and foreign laws. Like most firms, we have been and will continue to be impacted by regulatory and legislative changes. Responding to these changes, and keeping abreast of regulatory developments, has required us to incur costs that continue to impact our profitability.

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 the amount and composition of our assets under management, and the volatility and general level of securities prices and interest rates, among other things. 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. In the last few years, the industry has seen flows into products for which we do not currently garner significant market share. 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, 2013.

Our strategy is focused on four primary areas listed below. Management keeps these strategic priorities in mind when it evaluates our operating performance and financial condition. Consistent with this approach, we have also presented in the table below the most important matters on which management currently focuses in evaluating our performance and financial condition.

  Strategic Priorities                          Recent Initiatives
 Products                Create an innovative portfolio of investment solutions and
                           promote revenue growth through new product development and
                           leveraging the capabilities of our affiliates
                          Identify and execute strategic acquisitions to increase
                           product offerings and fill gaps in products and services

 Performance             Deliver compelling and consistent performance against both
                           relevant benchmarks and the products and services of our
                           competitors for 1-year, 3-year, 5-year, and 10-year periods

 Distribution            Evaluation and reallocation of resources within and to our
                           distribution platform to continue to build a top tier
                           distribution function with the capability to offer solutions
                           to relevant investment challenges and grow market share
                           worldwide

 Productivity            Operate with the highest level of effectiveness and
                           efficiency

                          Management of expenses

                          Restructuring of affiliate economic arrangements

The strategic priorities discussed above are designed to improve our operating margin, net flows, earnings, cash flows, assets under management ("AUM") and other key metrics. Certain of these key metrics are discussed in our quarterly results discussion to follow.


Net Income Attributable to Legg Mason, Inc. for the three months ended June 30, 2013, was $47.8 million, or $0.38 per diluted share, as compared to Net Loss Attributable to Legg Mason, Inc. of $9.5 million, or $0.07 per diluted share, for the three months ended June 30, 2012. The three months ended June 30, 2013, includes $26.3 million, or $0.14 per diluted share, in structuring fees related to a successful closed-end fund launch, which resulted in approximately $1.0 billion in AUM. The loss for the three months ended June 30, 2012, was primarily attributable to a $69.0 million, or $0.32 per diluted share, non-operating charge from the extinguishment of debt. In addition, the three months ended June 30, 2012, included $22.7 million, or $0.11 per diluted share, in structuring fees related to closed-end fund and real estate investment trust ("REIT") launches.

Average AUM, and total revenues, increased slightly during the three months ended June 30, 2013, as compared to the three months ended June 30, 2012. Strong overall investment performance contributed to a continued reduction in outflows in the 12-month period ended June 30, 2013. Over this period, the outflows we experienced were more than offset by increases in AUM due to market performance, an acquisition, and new product launches.

The following discussion and analysis provides additional information regarding our financial condition and results of operations.

Business Environment
During the three months ended June 30, 2013, the U.S. economy continued to exhibit the slow, steady growth that has been experienced in recent quarters, driven by a broad range of positive economic news including improvements in the housing sector and consumer confidence. In the month of June, the markets, particularly fixed income markets, exhibited volatility and experienced declines in reaction to comments from Federal Reserve officials indicating that its asset purchase program may be scaled back in the near future, showing the still fragile state of the economic recovery.

All three major U.S. equity market indices increased, while both the Barclays Capital U.S. Aggregate Bond Index and Barclays Capital Global Aggregate Bond Index decreased for the three months ended June 30, 2013, as illustrated in the table below:

                                                               % Change for the three months ended
                                                                             June 30:
Indices(1)                                                          2013                  2012
Dow Jones Industrial Average                                       2.3  %               (2.5 )%
S&P 500                                                            2.4  %               (3.3 )%
NASDAQ Composite Index                                             4.2  %               (5.1 )%

Barclays Capital U.S. Aggregate Bond Index (2.3 )% 2.1 % Barclays Capital Global Aggregate Bond Index (2.8 )% 0.6 %

(1) Indices are trademarks of Dow Jones & Company, McGraw-Hill Companies, Inc., NASDAQ Stock Market, Inc., and Barclays Capital, respectively, which are not affiliated with Legg Mason.

During the three months ended June 30, 2013, the Federal Reserve Board held the federal funds rate at 0.25%. We expect economic challenges and volatility in financial markets to persist and cannot predict how these factors will impact our results.


Quarter Ended June 30, 2013, Compared to Quarter Ended June 30, 2012

Assets Under Management

Our AUM is primarily managed across the following asset classes:
Equity                          Fixed Income                      Liquidity

   Small Cap Core                 U.S. Intermediate                U.S. Managed Cash
                                  Investment Grade
  Large Cap Growth               Global Government                U.S. Municipal Cash
  Equity Income                  U.S. Municipal
  Large Cap Value                Global Opportunistic
                                   Fixed Income
  Mid Cap Core                   U.S. Long Duration
  Global Equity                  U.S. Credit Aggregate
  International Equity           U.S. Limited Duration
  Global Emerging Market         Emerging Markets
   Equity
                                  U.S. High Yield
                                  Global Fixed Income

The components of the changes in our AUM (in billions) for the three months ended June 30, were as follows:

                                                   2013        2012
Beginning of period                              $ 664.6     $ 643.3
Investment funds, excluding liquidity funds(1)
Subscriptions                                       13.6        11.5
Redemptions                                        (15.7 )     (10.9 )
Separate account flows, net                          1.7        (4.1 )
Liquidity fund flows, net                           (8.1 )       0.9
Net client cash flows                               (8.5 )      (2.6 )
Market performance and other (2)                   (11.6 )      (4.3 )
Acquisitions (dispositions), net                       -        (4.6 )
End of period                                    $ 644.5     $ 631.8

(1) Subscriptions and redemptions reflect the gross activity in the funds and include assets transferred between funds and between share classes.
(2) Includes impact of foreign exchange of $5.8 billion, primarily on fixed income assets, and $0.7 billion, for the three months ended June 30, 2013 and 2012, respectively. Also includes reinvestment of dividends and other.

AUM at June 30, 2013, was $644.5 billion, a decrease of $20.1 billion, or 3%, from March 31, 2013. The decrease in AUM was attributable to the negative impact of market performance and other of $11.6 billion primarily driven by fixed income market declines, and net outflows of $8.5 billion. Market performance includes the negative impact of foreign currency exchange fluctuations of $5.8 billion. Net client outflows were driven by outflows in the liquidity asset class of $8.7 billion, which were slightly offset by long-term asset net inflows of $0.2 billion. The long-term asset inflows were driven by inflows in the fixed income asset class of $0.9 billion, which were offset in part by outflows in the equity asset class of $0.7 billion. The majority of fixed income inflows were in products managed by Brandywine Global Investment Management, LLC ("Brandywine") and were offset in part by outflows at Western Asset Management Company ("Western Asset"), including $1.3 billion in outflows from a single, low-fee global sovereign mandate. We expect to continue to experience outflows from this mandate of approximately $300 million to $500 million per month during fiscal 2014. We have experienced outflows in our fixed income asset class in all but three quarters since the fourth quarter of fiscal 2008. Equity outflows were primarily experienced in products managed at Royce & Associates ("Royce"), The Permal Group, Ltd. ("Permal"), and Batterymarch Financial Management, Inc. ("Batterymarch"), and were offset in part by inflows at ClearBridge Investments, LLC ("ClearBridge"). Due in part to investment performance, we have experienced outflows in our equity asset class in all but one quarter since fiscal 2007.


AUM increased by $12.7 billion, or 2%, from June 30, 2012. The AUM increase was attributable to $26.9 billion in market appreciation and other and $5.4 billion related to the acquisition of Fauchier Partners Management Limited ("Fauchier") in March 2013. These increases were partially offset by net client outflows and dispositions of $17.6 billion and $2.0 billion, respectively. Long-term asset net outflows from our equity and fixed income asset classes were $17.3 billion and $10.2 billion, respectively. Liquidity net inflows were $9.9 billion. Equity outflows were primarily in products managed at Batterymarch, Royce, Permal, and Legg Mason Capital Management LLC, while ClearBridge experienced net equity inflows. Fixed income outflows in products managed by Western Asset, which included $6.0 billion in outflows from the single, low-fee global sovereign mandate previously mentioned, were offset in part by net inflows in products managed by Brandywine. Dispositions of $2.0 billion were comprised of liquidity assets, transferred in connection with the amendment of historical Smith Barney brokerage programs.

AUM by Asset Class
AUM by asset class (in billions) as of June 30 was as follows:
                           % of                % of       %
                 2013     Total      2012     Total    Change
Equity         $ 164.4      26 %   $ 151.1      24 %     9  %
Fixed Income     351.0      54       360.6      57      (3 )
Liquidity        129.1      20       120.1      19       7
Total          $ 644.5     100 %   $ 631.8     100 %     2  %

The component changes in our AUM by asset class (in billions) for the three months ended June 30 were as follows:

                                                            Fixed
                                               Equity      Income      Liquidity       Total
March 31, 2013                                $ 161.8     $ 365.1     $    137.7     $ 664.6
Investment funds, excluding liquidity funds
Subscriptions                                     6.9         6.7              -        13.6
Redemptions                                      (7.6 )      (8.1 )            -       (15.7 )
Separate account flows, net                         -         2.3           (0.6 )       1.7
Liquidity fund flows, net                           -           -           (8.1 )      (8.1 )
Net client cash flows                            (0.7 )       0.9           (8.7 )      (8.5 )
Market performance and other                      3.3       (15.0 )          0.1       (11.6 )
June 30, 2013                                 $ 164.4     $ 351.0     $    129.1     $ 644.5



                                                            Fixed
                                               Equity      Income      Liquidity       Total
March 31, 2012                                $ 163.4     $ 356.1     $    123.8     $ 643.3
Investment funds, excluding liquidity funds
Subscriptions                                     5.1         6.4              -        11.5
Redemptions                                      (5.8 )      (5.1 )            -       (10.9 )
Separate account flows, net                      (3.2 )      (1.2 )          0.3        (4.1 )
Liquidity fund flows, net                           -           -            0.9         0.9
Net client cash flows                            (3.9 )       0.1            1.2        (2.6 )
Market performance and other                     (8.4 )       4.4           (0.3 )      (4.3 )
Dispositions                                        -           -           (4.6 )      (4.6 )
June 30, 2012                                 $ 151.1     $ 360.6     $    120.1     $ 631.8


The component changes in our AUM by asset class (in billions) for the trailing twelve months ended June 30, were as follows:

                                                            Fixed
                                               Equity      Income      Liquidity       Total
June 30, 2012                                 $ 151.1     $ 360.6     $    120.1     $ 631.8
Investment funds, excluding liquidity funds
Subscriptions                                    20.6        26.3              -        46.9
Redemptions                                     (28.2 )     (25.5 )            -       (53.7 )
Separate account flows, net                      (9.7 )     (11.0 )         (0.9 )     (21.6 )
Liquidity fund flows, net                           -           -           10.8        10.8
Net client cash flows                           (17.3 )     (10.2 )          9.9       (17.6 )
Market performance and other                     25.2         0.6            1.1        26.9
Acquisition (dispositions)                        5.4           -           (2.0 )       3.4
June 30, 2013                                 $ 164.4     $ 351.0     $    129.1     $ 644.5



                                                            Fixed
                                               Equity      Income      Liquidity       Total
June 30, 2011                                 $ 181.5     $ 365.4     $    115.6     $ 662.5
Investment funds, excluding liquidity funds
Subscriptions                                    19.6        25.6              -        45.2
Redemptions                                     (28.0 )     (20.6 )            -       (48.6 )
Separate account flows, net                     (11.0 )     (23.6 )         (0.1 )     (34.7 )
Liquidity fund flows, net                           -           -           11.7        11.7
Net client cash flows                           (19.4 )     (18.6 )         11.6       (26.4 )
Market performance and other                     (9.2 )      14.8           (0.8 )       4.8
Dispositions                                     (1.8 )      (1.0 )         (6.3 )      (9.1 )
June 30, 2012                                 $ 151.1     $ 360.6     $    120.1     $ 631.8

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

                           % of                % of       %
                 2013     Total      2012     Total    Change
Equity         $ 163.8      25 %   $ 155.1      24 %     6 %
Fixed Income     362.6      55       358.5      57       1
Liquidity        128.3      20       121.9      19       5
Total          $ 654.7     100 %   $ 635.5     100 %     3 %

AUM by Distribution Channel
Broadly, we have two principal distribution channels, Global Distribution and Affiliate/Other, through which we sell a variety of investment products and services. Global Distribution, which consists of our centralized global distribution operations, principally sells U.S. and international mutual funds and other commingled vehicles, retail separately managed account programs, and sub-advisory accounts for insurance companies and similar clients. Affiliate/Other consists of the distribution operations within our asset managers, which principally sell institutional separate account strategies and liquidity (money market) funds.


The component changes in our AUM by distribution channel (in billions) for the three months ended June 30, 2013 and 2012, were as follows:

                                             Global Distribution      Affiliate/Other        Total
March 31, 2013                              $            232.1       $         432.5     $      664.6
Net client cash flows, excluding
liquidity funds                                           (1.0 )                 0.6             (0.4 )
Liquidity fund flows, net                                    -                  (8.1 )           (8.1 )
Net client cash flows                                     (1.0 )                (7.5 )           (8.5 )
Market performance and other                               0.6                 (12.2 )          (11.6 )
June 30, 2013                               $            231.7       $         412.8     $      644.5



                                             Global Distribution      Affiliate/Other        Total
March 31, 2012                              $            220.6       $         422.7     $      643.3
Net client cash flows, excluding
liquidity funds                                            1.3                  (4.8 )           (3.5 )
Liquidity fund flows, net                                    -                   0.9              0.9
Net client cash flows                                      1.3                  (3.9 )           (2.6 )
Market performance and other                              (4.4 )                 0.1             (4.3 )
Dispositions                                                 -                  (4.6 )           (4.6 )
June 30, 2012                               $            217.5       $         414.3     $      631.8

For each of the three months ended June 30, 2013 and 2012, our overall effective fee rate across all asset classes and distribution channels was 34 basis points. Fees for managing equity assets are generally higher, averaging approximately 75 basis points for each of the quarters ended June 30, 2013 and 2012. This compares to fees for managing fixed income assets, which averaged approximately 25 basis points for each of the quarters ended June 30, 2013 and 2012, and liquidity assets, which averaged under 10 basis points (reflecting the impact of current advisory fee waivers due to the low interest rate environment) for each of the quarters ended June 30, 2013 and 2012. Equity assets are primarily managed by ClearBridge, Royce, Batterymarch, Permal and Brandywine, with fixed income assets primarily managed by Western Asset and Brandywine, and liquidity assets managed by Western Asset. Fee rates for assets distributed through Legg Mason Global Distribution, which are predominately retail in nature, averaged approximately 50 basis points for each of the quarters ended June 30, 2013 and 2012, while fee rates for assets distributed through the Affiliate/Other channel averaged approximately 30 basis points for each of the quarters ended June 30, 2013 and 2012.

Investment Performance
Our overall investment performance in the three months ended June 30, 2013, was generally positive compared to relevant benchmarks.

For the three months ended June 30, 2013, most U.S. equity indices produced positive returns. The best performing was the NASDAQ Composite, returning 4.15% for the three months ended June 30, 2013. These returns were achieved in an economic environment characterized by continued domestic growth and improved economic data, mixed with heightened sensitivity to economic news.

In the fixed income markets, while the Federal Reserve affirmed its commitment to hold the federal funds rate at historic lows, it did indicate that it may begin to reduce the bond buying program later in the year from the current monthly level of $85 billion should economic data warrant. Investors were generally cautious in assuming risk over the quarter, particularly in the month of June 2013 after the Federal Reserve's bond buying program statement, causing debt financial markets across most sectors to turn negative for the quarter. The lowest yielding fixed income sector for the quarter was U.S. TIPS, as measured by the Barclays U.S. TIPS Index returning (7.05)%. The best performing fixed income sector for the quarter was high yield bonds as measured by the Barclays U.S. High Yield Bond Index returning (1.44)% as of June 30, 2013.


The following table presents a summary of the percentages of our AUM by strategy(1) that outpaced their respective benchmarks as of June 30, 2013 and 2012, for the trailing 1-year, 3-year, 5-year, and 10-year periods:

                                    As of June 30, 2013                          As of June 30, 2012
                         1-year     3-year     5-year     10-year     1-year     3-year     5-year     10-year
Total (includes
liquidity)                   83 %       84 %       85 %        91 %       68 %       80 %       74 %        91 %
Equity:
Large cap                    54 %       72 %       79 %        71 %       35 %       30 %       66 %        80 %
Small cap                    21 %       21 %       26 %        68 %       12 %       13 %       51 %        82 %
Total equity (includes
other equity)                47 %       51 %       56 %        70 %       26 %       26 %       54 %        79 %
Fixed income:
U.S. taxable                 95 %       93 %       90 %        97 %       77 %       95 %       71 %        89 %
U.S. tax-exempt             100 %      100 %      100 %       100 %      100 %      100 %      100 %        98 %
Global taxable               90 %       94 %       96 %        93 %       62 %       97 %       71 %        96 %
Total fixed income           94 %       94 %       93 %        96 %       74 %       96 %       73 %        93 %

The following table presents a summary of the percentages of our U.S. mutual fund assets(2) that outpaced their Lipper category averages as of June 30, 2013 and 2012, for the trailing 1-year, 3-year, 5-year, and 10-year periods:

                                    As of June 30, 2013                          As of June 30, 2012
                         1-year     3-year     5-year     10-year     1-year     3-year     5-year     10-year
Total long-term
(excludes liquidity)         54 %       61 %       58 %        71 %       61 %       55 %       77 %        78 %
Equity:
Large cap                    50 %       77 %       62 %        52 %       81 %       60 %       55 %        71 %
Small cap                    28 %       17 %       29 %        76 %       26 %       25 %       87 %        90 %
Total equity (includes
other equity)                46 %       46 %       45 %        62 %       50 %       39 %       71 %        75 %
Fixed income:
U.S. taxable                 73 %       90 %       85 %        92 %       72 %       90 %       85 %        84 %
U.S. tax-exempt              62 %       88 %       85 %        85 %       86 %       69 %       91 %        82 %
Global taxable               66 %       67 %       71 %        57 %       81 %       84 %       92 %        90 %
Total fixed income           68 %       86 %       83 %        87 %       79 %       81 %       88 %        84 %

(1) For purposes of investment performance comparisons, strategies are an aggregation of discretionary portfolios (separate accounts, investment funds, and other products) into a single group that represents a particular investment objective. In the case of separate accounts, the investment performance of the account is based upon the performance of the strategy to which the account has been assigned. Each of our asset managers has its own specific guidelines for including portfolios in their strategies. For those managers which manage both separate accounts and investment funds in the same strategy, the performance comparison for all . . .

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