SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarter Ended December 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 1-8529
LEGG MASON, INC.
(Exact name of registrant as specified in its charter)
MARYLAND 52-1200960
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 Light Street - Baltimore, MD 21202
(Address of principal executive offices) (Zip code)
(410) 539-0000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Sections 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes X No _____
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
64,778,842 shares of common stock and 2,340,917 exchangeable shares as
of the close of business on February 6, 2003. The exchangeable shares,
which were issued by Legg Mason Canada Holdings in connection with the
acquisition of Perigee Inc., are exchangeable at any time into common
stock on a one-for-one basis and entitle holders to dividend, voting and
other rights equivalent to common stock.
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
LEGG MASON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
(In thousands, except per share amounts)
(Unaudited)
Three months Nine months
ended December 31, ended December 31,
2002 2001 2002 2001
Revenues
Investment advisory and related fees $215,911 $208,003 $ 641,392 $ 559,275
Commissions......................... 79,741 80,861 243,707 243,606
Principal transactions.............. 39,811 37,856 117,234 102,309
Investment banking.................. 23,384 24,443 82,994 72,061
Interest............................ 26,588 33,496 86,394 137,082
Other............................... 15,536 19,146 42,142 43,424
Total revenues.................... 400,971 403,805 1,213,863 1,157,757
Interest expense.................... 21,216 29,039 70,318 101,601
Net revenues...................... 379,755 374,766 1,143,545 1,056,156
Non-Interest Expenses
Compensation and benefits........... 225,078 226,470 677,692 642,705
Communications and technology....... 22,519 24,187 68,044 75,328
Occupancy........................... 16,044 15,232 49,167 46,219
Amortization of intangibles......... 6,207 6,258 18,752 12,602
Other............................... 33,086 35,615 100,466 101,977
Total non-interest expenses....... 302,934 307,762 914,121 878,831
Earnings Before Income Tax Provision... 76,821 67,004 229,424 177,325
Income tax provision................ 28,967 25,916 87,181 70,486
Net Earnings .......................... $ 47,854 $ 41,088 $ 142,243 $ 106,839
Earnings per common share
Basic............................... $ 0.73 $ 0.63 $ 2.16 $ 1.64
Diluted............................. $ 0.70 $ 0.60 $ 2.07 $ 1.57
Weighted average number of common
shares outstanding
Basic............................... 65,982 65,399 65,999 65,075
Diluted............................. 68,737 68,198 68,782 68,093
Dividends declared per common share.... $ 0.11 $ 0.10 $ 0.32 $ 0.29
Book value per common share at end
of period............................. $ 18.02 $ 15.65
See notes to consolidated financial statements.
3
LEGG MASON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in thousands)
December 31, March 31, 2002
2002
(Unaudited)
Assets
Cash and cash equivalents.................... $ 825,091 $ 468,377
Cash and securities segregated for regulatory
purposes or deposited with clearing
organizations............................... 2,616,639 2,501,613
Receivables:
Customers................................... 923,207 996,123
Investment advisory and related fees........ 124,611 114,546
Brokers and dealers and other............... 106,139 119,058
Securities borrowed.......................... 241,240 324,417
Financial instruments owned, at fair value... 173,110 133,709
Investment securities, at fair value......... 30,900 27,737
Investments of finance subsidiaries.......... 17,767 97,263
Equipment and leasehold improvements, net.... 71,115 69,146
Intangible assets, net....................... 477,659 494,001
Goodwill..................................... 454,956 443,422
Other........................................ 153,065 150,202
Total Assets.................................. $6,215,499 $5,939,614
Liabilities and Stockholders' Equity
Liabilities
Payables:
Customers.................................. $3,396,482 $3,249,522
Brokers and dealers........................ 32,029 35,009
Securities loaned........................... 207,690 279,615
Short-term borrowings....................... 112,207 3,560
Financial instruments sold, but not yet
purchased, at fair value.................. 62,237 37,909
Accrued compensation........................ 191,812 202,433
Other....................................... 188,611 169,896
Notes payable of finance subsidiaries....... 30,672 97,659
Long-term debt.............................. 784,909 779,463
Total Liabilities............................ 5,006,649 4,855,066
Commitments and Contingencies (Note 8)
Stockholders' Equity
Common stock................................ 6,474 6,444
Shares exchangeable into common stock....... 8,820 9,400
Additional paid-in capital.................. 357,891 358,972
Deferred compensation and employee note
receivable................................. (31,348) (32,007)
Employee stock trust........................ (105,252) (90,674)
Deferred compensation employee stock trust.. 105,252 90,674
Retained earnings........................... 872,378 751,635
Accumulated other comprehensive loss, net... (5,365) (9,896)
Total Stockholders' Equity................... 1,208,850 1,084,548
Total Liabilities and Stockholders' Equity.... $6,215,499 $5,939,614
See notes to consolidated financial statements.
4
LEGG MASON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)
Nine months ended
December 31,
2002 2001
Cash Flows from Operating Activities:
Net earnings........................................ $142,243 $106,839
Non-cash items included in earnings:
Depreciation and amortization..................... 41,491 32,448
Accretion and amortization of securities discounts
and premiums, net............................... 5,762 5,776
Originated mortgage servicing rights.............. (956) (1,602)
Deferred compensation............................. 7,452 6,300
Unrealized (gains)losses on investments........... 2,148 (3,331)
Other............................................. 1,389 1,441
Deferred income taxes.............................. 6,320 12,056
Decrease(increase) in assets excluding acquisitions:
Cash and securities segregated for regulatory
purposes or deposited with clearing organizations. (115,026) (393,651)
Receivable from customers.......................... 72,916 75,674
Receivable from investment advisory and related
fees.............................................. (9,795) (1,444)
Receivable from brokers and dealers and other...... 13,464 (35,999)
Securities borrowed................................ 83,177 (96,087)
Financial instruments owned........................ (39,401) (45,957)
Other.............................................. (1,740) (9,517)
Increase (decrease) in liabilities excluding
acquisitions:
Payable to customers............................... 146,960 462,557
Payable to brokers and dealers..................... (2,980) (22,165)
Securities loaned.................................. (71,925) 47,303
Financial instruments sold, but not yet purchased.. 24,328 10,333
Accrued compensation............................... (10,864) (6,227)
Other.............................................. 4,890 7,954
Cash Provided by Operating Activities................ 299,853 152,701
Cash Flows from Investing Activities:
Payments for:
Equipment and leasehold improvements.............. (22,257) (14,973)
Asset management contracts and mortgage servicing
portfolios....................................... - (2,658)
Acquisitions, net of cash acquired................ (3,217) (794,522)
Net increase in securities purchased under
agreements to resell.............................. - (20,000)
Purchases of investment securities.................. (25,584) (8,649)
Proceeds from sales and maturities of investment
securities........................................ 113,305 33,814
Cash Provided by (Used for) Investing Activities..... 62,247 (806,988)
5
LEGG MASON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(continued)
(Dollars in thousands)
(Unaudited)
Nine months ended
December 31,
2002 2001
Cash Flows from Financing Activities:
Net increase in short-term borrowings............... 108,647 95,467
Net proceeds from issuance of long-term debt........ - 664,554
Repayment of notes payable of finance subsidiaries.. (80,368) (26,676)
Issuance of common stock............................ 19,440 16,983
Repurchase of common stock.......................... (33,438) -
Dividends paid...................................... (20,810) (18,481)
Cash (Used for) Provided by Financing Activities..... (6,529) 731,847
Effect of Exchange Rate Changes on Cash.............. 1,143 1,573
Net Increase in Cash and Cash Equivalents........... 356,714 79,133
Cash and Cash Equivalents at Beginning of Period..... 468,377 556,148
Cash and Cash Equivalents at End of Period........... $825,091 $635,281
SUPPLEMENTAL DISCLOSURE:
Noncash activity:
The value of common stock issued in connection with a business acquisition was
$3,262 for the nine months ended December 31, 2002.
See notes to consolidated financial statements.
6
LEGG MASON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in thousands)
(Unaudited)
Three months ended Nine months ended
December 31, December 31,
2002 2001 2002 2001
Net earnings........................... $47,854 $41,088 $142,243 $106,839
Other comprehensive income:
Foreign currency translation
adjustment.......................... 1,729 (822) 6,920 1,392
Unrealized gains(losses)on investment
securities:
Unrealized holding gains (losses)
arising during the period......... (469) (3,003) (896) (2,353)
Reclassification adjustment for
(gains)losses included in net
income............................ 152 (680) 242 (840)
Net unrealized gains (losses)...... (317) (3,683) (654) (3,193)
Deferred gains (losses) on cash flow
hedges............................... - - (2,726) -
Deferred income taxes.................. (61) 1,371 991 1,135
Total other comprehensive income...... 1,351 (3,134) 4,531 (666)
Comprehensive income................... $49,205 $37,954 $146,774 $106,173
See notes to consolidated financial statements.
7
LEGG MASON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
December 31, 2002
(Unaudited)
1. Interim Basis of Reporting:
The accompanying unaudited interim consolidated financial
statements of Legg Mason, Inc. and its subsidiaries (collectively
"Legg Mason") have been prepared in accordance with accounting
principles generally accepted in the United States of America for
interim financial information. The interim consolidated financial
statements have been prepared utilizing the interim basis of reporting
and, as such, reflect all adjustments (consisting only of normal
recurring adjustments) which are, in the opinion of management,
necessary for a fair presentation of the results for the periods
presented. The nature of Legg Mason's business is such that the
results of any interim period are not necessarily indicative of the
results for a full year.
The information contained in the interim consolidated financial
statements should be read in conjunction with Legg Mason's latest
Annual Report on Form 10-K filed with the Securities and Exchange
Commission. Where appropriate, prior year's financial statements have
been reclassified to conform to the current year's presentation.
Unless otherwise noted, all per share amounts include both common
shares of Legg Mason and shares issued in connection with the
acquisition of Perigee Inc., which are exchangeable into common shares
of Legg Mason on a one-for-one basis at any time.
The interim consolidated financial statements are prepared in
accordance with accounting principles generally accepted in the United
States of America, which require management to make assumptions and
estimates that affect the amounts reported in the interim consolidated
financial statements and accompanying notes. Actual amounts could
differ from those estimates and the differences could have a material
impact on the interim consolidated financial statements.
2. Net Capital Requirements:
Legg Mason's broker-dealer subsidiaries are subject to the
Securities and Exchange Commission's Uniform Net Capital Rule. The
Rule provides that equity capital may not be withdrawn or cash
dividends paid if resulting net capital would fall below specified
levels. As of December 31, 2002, the broker-dealer subsidiaries had
aggregate net capital, as defined, of $331,190, which exceeded
required net capital by $311,523.
3. Financial Instruments Owned, at Fair Value:
At December 31, 2002, Legg Mason had pledged securities of $754
as collateral to counterparties for securities loaned transactions,
which can be sold or repledged by the counter parties.
8
4. Intangible Assets and Goodwill:
The following table reflects the components of intangible assets
as of December 31, 2002:
Cost Accumulated
Amortization
Amortized intangible assets:
Asset management contracts $359,392 $47,018
Mortgage servicing contracts 9,883 3,858
Total amortized intangible assets $369,275 $50,876
Indefinite-life intangible assets:
Fund management contracts $104,560 $ -
Trade names 54,700 -
Total indefinite-life intangible assets $159,260 $ -
Included in other expenses on the consolidated statements of
earnings and other non-cash items included in earnings on the
consolidated statements of cash flows are impairment charges of $687
and $1,200 for the nine months ended December 31, 2002 and 2001,
respectively, related to Legg Mason's Asset Management segment. These
charges represent the unamortized balance of acquired asset management
contracts that were terminated.
Estimated amortization expense for each of the next five fiscal
years is as follows:
Fiscal year ended March 31: Amount
2003 $24,888
2004 23,655
2005 23,347
2006 22,870
2007 22,116
The carrying value of goodwill of $454,956 at December 31, 2002
is primarily attributable to Legg Mason's asset management reporting
segment. The increase in the carrying value of goodwill since March
31, 2002 primarily reflects approximately $6,400 from the impact of
changes in foreign currency exchange rates, approximately $3,000
related to an increase in ownership interest in Barrett Associates,
Inc. and approximately $1,800 from the acquisition of the assets of an
investment advisor which was not material to Legg Mason's financial
statements.
9
5. Short-Term Borrowings:
At December 31, 2002, Legg Mason had an outstanding borrowing of
$112,207 under a compensating balance arrangement. The proceeds of
the borrowing were used to purchase short-term, highly liquid
securities. These securities are pledged as collateral for the credit
facility and, due to their characteristics, are classified as cash
equivalents on the December 31, 2002 Statement of Financial Condition.
As the securities mature, the cash proceeds are used to pay-down the
outstanding balance of the credit facility or to purchase additional
securities, which are then pledged as collateral for the borrowing.
6. Earnings Per Share:
Basic earnings per share ("EPS") is calculated by dividing net
earnings by the weighted average number of common shares outstanding.
Diluted EPS is similar to basic EPS, but adjusts for the effect of
potential common shares.
The following tables present the computations of basic and
diluted EPS for the three and nine months ended December 31, 2002 and
2001 (shares in thousands):
Three months ended December 31,
2002 2001
Basic Diluted Basic Diluted
Weighted average common
shares outstanding 65,982 65,982 65,399 65,399
Potential common shares:
Employee stock options - 2,233 - 2,309
Shares related to
deferred compensation - 522 - 490
Weighted average common
and common equivalent
shares outstanding 65,982 68,737 65,399 68,198
Net earnings applicable
to common stock $47,854 $47,854 $41,088 $41,088
Earnings per common share $ 0.73 $ 0.70 $ 0.63 $ 0.60
10
Nine months ended December 31,
2002 2001
Basic Diluted Basic Diluted
Weighted average common
shares outstanding 65,999 65,999 65,075 65,075
Potential common shares:
Employee stock options - 2,255 - 2,522
Shares related to
deferred compensation - 528 - 496
Weighted average common
and common equivalent
shares outstanding 65,999 68,782 65,075 68,093
Net earnings applicable
to common stock $142,243 $142,243 $106,839 $106,839
Earnings per common share $ 2.16 $ 2.07 $ 1.64 $ 1.57
7. Accounting Developments:
The following pronouncements have been issued by the Financial
Accounting Standards Board ("FASB") since March 31, 2002.
Statement of Financial Accounting Standards ("SFAS") No. 143,
"Accounting for Asset Retirement Obligations" requires the fair value
of a liability to be recorded for costs associated with the retirement
of tangible long-lived assets in the period in which the liability is
incurred if it can be reasonably estimated.
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-
Lived Assets" supercedes SFAS No. 121, "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to be Disposed Of."
This statement principally addresses implementation issues of SFAS No.
121, including developing a single accounting model for long-lived
assets to be disposed of by sale.
SFAS No. 145, "Rescission of FASB Statements Nos. 4, 44 and 64,
Amendment of FASB Statement No. 13, and Technical Corrections as of
April 2002" primarily provides guidance for reporting gains and losses
from extinguishments of debt and sale-leaseback transactions.
SFAS No. 146, "Accounting for Costs Associated with Exit or
Disposal Activities". This standard requires companies to recognize
costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or
disposal plan. SFAS No. 146 replaces the existing guidance provided by
EITF Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring)." SFAS No. 146 is to be
11
applied prospectively to exit or disposal activities initiated after
December 31, 2002.
SFAS No. 147, "Acquisitions of Certain Financial Institutions -
an Amendment of FASB Statements No. 72 and 144 and FASB Interpretation
No. 9". This statement provides guidance on the accounting for the
acquisition of a financial institution, which had previously been
addressed in SFAS No. 72, "Accounting for Certain Acquisitions of
Banking or Thrift Institutions," and requires that those transactions
be accounted for in accordance with SFAS No. 141, "Business
Combinations", and SFAS No. 142, " Goodwill and Other Intangible
Assets." In addition, this statement amends SFAS No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets," to include long-
term customer-relationship intangible assets, other than those with
indefinite lives, and would require these assets to be subject to an
undiscounted cash flow recoverability impairment test that SFAS No.
144 requires for other long-lived assets that are held and used.
SFAS No. 148 "Accounting for Stock-Based Compensation -
Transition and Disclosure - an amendment of FASB Statement No. 123"
amends SFAS No. 123, "Accounting for Stock-Based Compensation". SFAS
148 provides alternative methods of transition for a voluntary change
to the fair value based method of accounting for stock-based employee
compensation. SFAS 148 also amends SFAS 123 to require prominent
disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the
effect of the method used on reported results. The disclosure
requirements of SFAS 148 are effective for Legg Mason's March 31, 2003
financial statements and interim periods thereafter.
FASB Interpretation Number ("FIN") 45 "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees
of Indebtedness of Others - an interpretation of FASB Statements No.
5, 57 and 107 and rescission of FASB Interpretation No. 34" expands
the disclosure requirements to be made by a guarantor in its interim
and annual financial statements regarding its obligations under
certain guarantees that it has issued. FIN 45 also requires, under
certain circumstances, the recognition, at the inception of a
guarantee, of a liability for the fair value of the obligation as a
result of issuing the guarantee. Guarantees of an entity's own future
performance are not within the scope of FIN 45.
FIN 46 "Consolidation of Variable Interest Entities - an
interpretation of ARB No. 51" requires the consolidation of the
assets, liabilities and results of operations of variable interest
entities ("VIE") by the primary beneficiary. FIN 46 also requires the
disclosure of information concerning variable interest entities by
entities that hold significant variable interests but may not be the
primary beneficiary. FIN 46 applies immediately to variable interest
entities created after January 31, 2003 and is effective for interim
periods beginning after June 15, 2003 for interests in variable
interest entities that were acquired before February 1, 2003. FIN 46
also requires the disclosure of the nature, purpose, size and
activities of variable interest entities, as well as the maximum
12
exposure to loss in connection with VIE's for any financial statements
issued after January 31, 2003 if it is reasonably possible that an
entity will consolidate or disclose information about a VIE when FIN
46 becomes effective.
During the nine months ended December 31, 2002, SFAS Nos. 143,
144, 145, 146 and 147 became effective and did not materially impact
the consolidated financial statements. We have adopted the disclosure
requirements of FIN 45 and 46 and are in the process of evaluating the
impact of the remaining provisions, which are effective in subsequent
periods. We will adopt the disclosure requirements of SFAS No. 148
for our March 31, 2003 financial statements.
8. Commitments and Contingencies:
Legg Mason leases office facilities and equipment under non-
cancelable operating leases and also has multi-year agreements for
data processing and other services. These leases and service
agreements expire on varying dates through 2015. Certain leases
provide for renewal options and contain escalation clauses providing
for increased rentals based upon maintenance, utility and tax
increases.
The minimum annual aggregate rentals for each fiscal year are as
follows:
Remaining 2003.................... $ 17,107
2004.............................. 60,464
2005.............................. 50,324
2006.............................. 42,146
2007.............................. 36,560
Thereafter........................ 115,946
Total............................. $ 322,547
In August 2002, one of Legg Mason's subsidiaries entered into a
ten-year lease commitment commencing May 2004 to replace its current
lease when it expires. Legg Mason, Inc. is a guarantor on the lease.
Additionally, in November 2002, another of Legg Mason's subsidiaries
entered into a ten-year lease commitment commencing August 2003 to
replace its current lease when it expires. The minimum annual
aggregate rentals under these leases are included in the table above.
Legg Mason, Inc. is also the guarantor of a lease for office space of
an unconsolidated joint venture. The lease extends through December
2010. At December 31, 2002, the maximum amount of future rental
payments that could be required under this guarantee is $7,962 over
the remaining term of the lease, and is excluded from the table above.
If required to pay under this guarantee, Legg Mason, Inc. would be
eligible to seek partial recovery from the other party to the joint
venture.
Legg Mason has been the subject of customer complaints and has
also been named as a defendant in various legal actions arising
primarily from securities brokerage, asset management and investment
13
banking activities, including certain class actions, which primarily
allege violations of securities laws and seek unspecified damages,
which could be substantial. Legg Mason has also been involved in
governmental and self regulatory agency investigations and
proceedings. In accordance with SFAS No. 5, "Accounting for
Contingencies," Legg Mason has established reserves for potential
losses that may result from pending complaints, legal actions,
investigations and proceedings. While the ultimate resolution of these
actions cannot be currently determined, in the opinion of management,
after consultation with legal counsel, the actions are expected to be
resolved with no material adverse effect on Legg Mason's financial
condition. However, if during any period a potential adverse
contingency should become probable or resolved, the results of
operations in that period could be materially affected. In addition,
the ultimate costs of litigation-related charges can vary
significantly from period to period, depending on factors such as
market conditions, the size and volume of customer complaints and
claims, including class action suits, and recoveries from
indemnification, contribution or insurance reimbursement.
9. Business Combinations and Dispositions:
Legg Mason acquired Royce & Associates, Inc. ("Royce") on October
1, 2001, and Private Capital Management, L.P. ("PCM") on August 1,
2001. The following unaudited pro-forma consolidated results are
presented as though the acquisitions of Royce and PCM had occurred at
the beginning of the period presented.
Nine months ended
December 31, 2001
Net revenues $1,101,571
Net earnings $ 115,954
Earnings per common share:
Basic $ 1.78
Diluted $ 1.70
Legg Mason has contractual obligations to make future payments in
connection with business acquisitions if the acquired entities achieve
certain revenue levels. These payments are payable through fiscal 2007
and will not exceed approximately $814,900.
During the nine months ended December 31, 2002, Legg Mason sold
certain contracts in its bank brokerage network for proceeds of
$1,600, which resulted in a pre-tax gain of $1,300. Additionally, the
sale provides for future contingent proceeds over the next two years
based on certain performance provisions. The total sales price is not
expected to exceed $3,200. The effect of the sale of these contracts
on Legg Mason's continuing net revenues and earnings before income
taxes is not material.
14
10. Business Segment Information:
Legg Mason currently operates through four business segments:
Asset Management, Private Client, Capital Markets and Other. The
business segments are based upon factors such as the services provided
and distribution channels served. Certain services that Legg Mason
offers are provided to clients through more than one of its business
segments. Legg Mason allocates certain common income and expense items
among its business segments based upon various methodologies and
factors. These methodologies are by their nature subjective and are
reviewed periodically by management. Business segment results in the
future may reflect reallocations of revenues and expenses that result
from changes in methodologies, but such reallocations will have no
effect on Legg Mason's consolidated results of operations.
The Asset Management segment provides investment advisory
services to company-sponsored investment funds and asset management
services to institutional and individual clients. Investment advisory
and related fees earned by Asset Management vary based upon factors
such as the type of underlying investment product, the amount of
assets under management and the type of services that are provided. In
addition, performance fees may be earned on certain investment
advisory contracts for meeting or exceeding performance benchmarks.
The Private Client segment distributes a wide range of financial
products through its branch distribution network, including equity and
fixed income securities, proprietary and non-affiliated mutual funds
and annuities. Private Client's primary sources of revenues consist of
commissions and principal credits earned on equity and fixed income
transactions in customer brokerage accounts, distribution fees earned
on mutual funds, fees earned on fee-based brokerage and managed
accounts and net interest from customers' margin loan and credit
account balances. Sales credits associated with underwritten offerings
initiated in the Capital Markets segment are reported in Private
Client when sold through its branch distribution network.
The Capital Markets segment consists of Legg Mason's equity and
fixed income institutional sales and trading and corporate and public
finance advisory and underwriting activities. Sales credits associated
with underwritten offerings are reported in Capital Markets when sold
through institutional distribution channels. The results of this
business segment also include realized and unrealized gains and losses
on investments acquired in connection with merchant banking and
investment banking activities.
The Other segment consists principally of Legg Mason's real
estate service business and unallocated corporate revenues and
expenses.
15
Business segment financial results are as follows:
Three months ended Nine months ended
December 31, December 31,
2002 2001 2002 2001
Net revenues:
Asset Management........... $165,810 $152,868 $ 480,477 $ 394,526
Private Client............. 143,125 151,823 445,182 461,322
Capital Markets............ 61,332 62,512 194,861 176,489
Other...................... 9,488 7,563 23,025 23,819
$379,755 $374,766 $1,143,545 $1,056,156
Earnings before income tax
provision:
Asset Management........... $ 47,540 $ 39,925 $ 134,010 $ 104,803
Private Client............. 16,389 15,212 56,002 41,965
Capital Markets............ 12,021 11,300 39,773 29,638
Other...................... 871 567 (361) 919
$ 76,821 $ 67,004 $ 229,424 $ 177,325
Legg Mason does not analyze asset information in all business
segments.
Legg Mason principally operates in the United States of America,
the United Kingdom and Canada. Revenues and expenses for geographic
purposes are allocated based on the location of the office providing the
service.
Results by geographic region are as follows:
Three months ended Nine months ended
December 31, December 31,
2002 2001 2002 2001
Net revenues:
United States............. $361,742 $355,982 $1,090,194 $1,001,309
United Kingdom............ 9,298 8,739 27,232 26,409
Canada.................... 5,726 7,152 18,351 22,068
Other..................... 2,989 2,893 7,768 6,370
$379,755 $374,766 $1,143,545 $1,056,156
Earnings before income tax
provision:
United States............. $ 74,852 $ 65,714 $ 224,760 $ 171,591
United Kingdom............ (697) (1,785) (2,916) (5,264)
Canada.................... 2,018 1,507 5,987 8,450
Other..................... 648 1,568 1,593 2,548
$ 76,821 $ 67,004 $ 229,424 $ 177,325
16
Item 2. Management's Discussion and Analysis of Results of Operations
and Financial Condition
Legg Mason, Inc., a holding company, and its subsidiaries (collectively
"Legg Mason") are principally engaged in providing asset management,
securities brokerage, investment banking and related financial services
to individuals, institutions, corporations and municipalities. We
currently operate through four business segments: Asset Management,
Private Client, Capital Markets and Other.
Our profitability may vary significantly from period to period as a
result of a variety of factors, including the amount of assets under
management, the volume of trading in securities, the volatility and
general level of securities prices and interest rates, the level of
customer margin and credit account balances and the demand for
investment banking services. Accordingly, sustained periods of
unfavorable market conditions may adversely affect our profitability.
For a further discussion of factors that may affect our results of
operations, refer to Item 1 "Business Factors Affecting the Company
and the Financial Services Industry" in our Annual Report on Form 10-K
for the fiscal year ended March 31, 2002.
Terms such as "we," "us," "our," and "company" refer to Legg Mason.
Business Environment
Despite increases in the major equity market indices during the quarter
ended December 31, 2002, market conditions continued to be volatile and
the future outlook uncertain due to a number of issues, including the
state of the domestic economy, the situations in Iraq and North Korea
and industry and corporate governance lapses in the United States. The
Dow Jones Industrial Average, the Nasdaq Composite Index and the S&P 500
were up 10%, 14% and 8%, respectively, for the quarter, but were down
20%, 28% and 23%, respectively, for the nine months ended December 31,
2002. During January 2003, the gains for the quarter as measured by the
major indices were erased. To help stimulate the economy, the U.S.
Federal Reserve lowered interest rates by 0.50% to 1.25%, the lowest
level since 1961. In addition, regulatory proceedings and
investigations of the relationships between research analysts and
investment banking operations at financial services companies has
created uncertainty as to whether companies in the industry will be
required to make significant changes in their research or investment
banking operations.
Consolidated Results of Operations
Net revenues, net earnings and diluted earnings per share were up 1% to
$379.8 million, 16% to $47.9 million and 17% to $0.70, respectively as
compared to the prior year's quarter, and were up 8% to $1.14 billion,
33% to $142.2 million and 32% to $2.07, respectively, as compared to the
prior nine month period. These increases were primarily the result of
the inclusion, and subsequent growth, of Royce & Associates, Inc.
("Royce") and Private Capital Management, L.P. ("PCM"). Royce and PCM
contributed increases in net revenues of $10.6 million and $79.8 million
for the quarter and nine months ended December 31, 2002, respectively.
17
Growth at our fixed income institutional investment advisor contributed
increased net revenues of $10.6 million for the quarter and $29.3
million for the nine months ended December 31, 2002. Additionally, net
earnings increased over the prior year periods as a result of decreases
in litigation related costs and cost savings initiatives. The increases
in the quarter and nine months ended December 31, 2002 were offset in
part by declines in revenues from company-sponsored equity mutual funds
of $9.7 million and $29.8 million, respectively. The increases in the
nine months ended December 31, 2002 were also offset in part by a
decline of $19.4 million in net interest profit. Compared to the
quarter ended September 30, 2002, net revenues, net earnings and diluted
earnings per share increased 2%, 5% and 6%, respectively. These
increases were primarily the result of a $7.6 million increase in
performance related investment advisory fees and reduced litigation
related expenses. If weaknesses in the equity markets and low investor
confidence continue, our revenues and profits are likely to be
negatively impacted.
Investment advisory and related fee revenue increased 4% to $215.9
million during the quarter ended December 31, 2002 as a result of a 9%
increase in assets under management and a $3.3 million increase in
performance fees earned at our fixed income institutional investment
advisor, as well as higher revenues of $6.6 million from Royce and $2.6
million from PCM. These increases were partially offset by declines of
$9.7 million in revenues from our company-sponsored equity mutual funds,
whose asset values decreased approximately 17% primarily as a result of
market depreciation, and lower revenues at our non-U.S. based investment
advisors of $3.2 million. Investment advisory and related fee revenue
for the nine months ended December 31, 2002 increased 15% to $641.4
million. This increase is primarily the result of the addition of $89.3
million of fees from Royce and PCM, and growth of $29.3 million in fees
from our fixed income institutional investment advisor, offset in part
by declines in fees from company-sponsored equity mutual funds of $29.8
million and lower revenues at our non-U.S. based investment advisors of
$9.5 million.
Revenues from securities brokerage activities, including both
commissions and principal transactions, increased 1% to $119.6 million
during the quarter ended December 31, 2002, primarily as a result of an
increase in sales of annuities and higher retail fixed income
transaction volume, offset in part by declines in listed and over-the-
counter retail securities transactions. Securities brokerage revenues
increased 4% to $360.9 million during the nine months ended December 31,
2002 as a result of increases in the volume of both retail and
institutional fixed income transactions and the addition of a full
period of commissions earned by PCM's brokerage operations. These
increases were offset in part by a decline in listed and over-the-
counter retail transaction volume.
Revenues from investment banking activities decreased 4% to $23.4
million during the quarter ended December 31, 2002, primarily due to a
decline in private placement and advisory revenues, partially offset by
an increase in institutional equity selling concessions and municipal
banking fees. Investment banking revenues increased 15% to $83.0
million during the nine months ended December 31, 2002, primarily due to
an increase in corporate selling concessions and an increase in
municipal banking fees.
18
Other revenues during the quarter ended December 31, 2002 decreased 19%
to $15.5 million, primarily as a result of $5.9 million of unrealized
gains on firm investments in the prior year's quarter. This decrease
was offset in part by an increase in loan origination fees earned at our
mortgage banking subsidiary. Other revenues during the nine months
ended December 31, 2002 decreased 3% to $42.1 million, primarily as a
result of $4.8 million of gains on firm investments in the prior year
period. This decline was offset in part by an increase in customer
related account fees and a $1.3 million realized gain on the sale of
certain contracts in our bank brokerage network.
Net interest profit increased 21% to $5.4 million from $4.5 million in
the prior year's quarter, primarily as a result of a decrease in
interest expense of $6.3 million on customer credit account balances,
due to lower average interest rates paid, and increased revenue of
$1.2 million on higher firm investment balances. These increases in
interest profit were partially offset by a decrease of $7.0 million in
interest earned on customer margin and firm investment balances due to
lower average interest rates. Net interest profit declined 55% to
$16.1 million from $35.5 million in the prior nine month period,
primarily as a result of a decrease of $45.4 million in interest
revenue due to lower average interest rates earned on customer account
and firm investment balances and an increase in interest expense of
$9.2 million as a result of an increase in acquisition-related debt.
These decreases in net interest profit were partially offset by a
decrease in interest expense of $35.0 million as a result of lower
average interest rates paid on customer credit account balances.
During the quarter and nine months ended December 31, 2002, net interest
profit accounted for 7% of consolidated pre-tax profits, remaining flat
from the prior year's quarter, and down significantly from 20% in the
prior nine month period.
19
Quarter Ended December 31, 2002 Compared to Quarter Ended December 31,
2001
Revenues By Segment
The following table sets forth, for the periods indicated, net revenues
and pre-tax earnings by business segment.
Three months ended
December 31,
2002 2001
Net revenues:
Asset Management........... $165,810 $152,868
Private Client............. 143,125 151,823
Capital Markets............ 61,332 62,512
Other...................... 9,488 7,563
$379,755 $374,766
Earnings before income tax
provision:
Asset Management........... $ 47,540 $ 39,925
Private Client............. 16,389 15,212
Capital Markets............ 12,021 11,300
Other...................... 871 567
$ 76,821 $ 67,004
Asset Management:
Net revenues in the Asset Management segment increased to $165.8
million, up 8% over the prior year's quarter. Pre-tax earnings were
$47.5 million, a 19% increase over the December 2001 quarter. The
increase in net revenues was primarily the result of increases in assets
under management at our fixed income institutional advisor, as well as
growth at Royce and PCM, offset in part by declines in fees from
company-sponsored equity mutual funds and lower revenues at our non-U.S.
based investment advisors. Expenses rose 3% as a result of increased
compensation costs on higher revenues, partially offset by $3.0 million
in increased litigation related costs and a $1.2 million intangible
asset impairment charge in the prior period. The pre-tax profit margin
increased to 29% from 26%. Asset Management represented 44% of
consolidated net revenues for the quarter ended December 31, 2002, an
increase from 41% in the corresponding quarter of the prior year. Total
assets under management were $184.7 billion as of December 31, 2002, an
increase of $14.6 billion or 9% from December 31, 2001. As of December
31, 2002, approximately $124.0 billion or 67% of assets under management
were fixed income related and $60.7 billion or 33% were equity related.
As of December 31, 2001, approximately $106.5 billion or 63% of assets
under management were fixed income related and $63.6 billion or 37% were
equity related. Our assets under management mix as of December 31, 2002
was as follows: Mutual Funds - $35.7 billion (19%); Institutional -
$129.5 billion (70%); and Wealth Management - $19.5 billion (11%).
20
Private Client:
Despite a decline in net revenues of $8.7 million or 6%, Private
Client's pre-tax earnings increased by $1.2 million or 8% over the prior
year's quarter. Improved pre-tax earnings resulted primarily from lower
compensation and profit sharing costs. These decreases in expenses more
than offset the $7.1 million reduction in net revenues that resulted
from a decline in distribution fee revenue on company-sponsored equity
mutual funds and lower retail securities transaction volume. The pre-
tax profit margin increased to 11% from 10%. Private Client represented
38% of consolidated net revenues in December 2002, a decrease from 41%
in the prior year's quarter.
Capital Markets:
Capital Markets net revenues of $61.3 million decreased 2% from $62.5
million in the prior year's quarter and pre-tax earnings rose $0.7
million to $12.0 million. The decline in net revenue was the result of
decreased corporate banking activities, lower volume of listed
institutional transactions and a decline in unrealized gains on warrants
acquired in connection with private placements. These decreases were
partially offset by an increase in municipal banking revenues and fixed
income trading profits. The improvement in pre-tax earnings was
primarily due to lower incentive compensation costs. The pre-tax profit
margin increased to 20% from 18%. Capital Markets represented 16% of
consolidated net revenues for the quarter December 31, 2002, a decrease
from 17% in the prior year's quarter.
Other:
Other revenues consist principally of the results of our real estate
service business and unallocated corporate revenues and expenses. Net
revenues increased 25% to $9.5 million from $7.6 million in the
corresponding prior year period, primarily due to an increase in loan
origination fees at our mortgage banking subsidiary, offset in part by
losses from limited partnership investments in the prior period.
Consolidated Expenses
Compensation and benefits:
Compensation and benefits decreased 1% to $225.1 million from $226.5
million in the prior year's quarter, primarily attributable to declines
in sales commissions on retail securities transactions and distribution
fees and lower costs related to our profit sharing plan. These
decreases were partially offset by an increase in incentive expense
related to Asset Management activities.
Communications and technology:
Communications and technology expense declined 7% to $22.5 million from
$24.2 million in the prior year's quarter, primarily as a result of
decreases in costs for consulting fees and leased computer equipment.
21
Occupancy:
Occupancy was $16.0 million, up 5% from $15.2 million in the
corresponding prior year quarter, primarily due to an increase in rent
as a result of additional expenses at our fixed income institutional
investment advisor and higher operating expenses at our corporate
headquarters.
Amortization of intangible assets:
Amortization of intangible assets of $6.2 million for the quarter ended
December 31, 2002 remained relatively unchanged from the prior year
quarter.
Other:
Other expenses decreased 7% to $33.1 million from $35.6 million in the
prior year's quarter, primarily as a result of a decrease in litigation
expenses of approximately $3.0 million and the impact of a $1.2 million
intangible asset impairment charge in the prior year's quarter, offset
in part by higher expenses related to advances to financial advisors.
Income tax provision:
The provision for income taxes increased 12% to $29.0 million, from
$25.9 million in the prior year's quarter, primarily as a result of the
increase in pre-tax earnings. The effective tax rate declined to 37.7%
in the December 2002 quarter from 38.7% in the December 2001 quarter as
a result of lower effective state income tax rates.
Nine Months Ended December 31, 2002 Compared to Nine Months Ended
December 31, 2001
Revenues By Segment
The following table sets forth, for the periods indicated, net revenues
and pre-tax earnings by business segment.
Nine months ended
December 31,
2002 2001
Net revenues:
Asset Management........... $ 480,477 $ 394,526
Private Client............. 445,182 461,322
Capital Markets............ 194,861 176,489
Other...................... 23,025 23,819
$1,143,545 $1,056,156
Earnings before income tax
provision:
Asset Management........... $ 134,010 $ 104,803
Private Client............. 56,002 41,965
Capital Markets............ 39,773 29,638
Other...................... (361) 919
$ 229,424 $ 177,325
22
Asset Management:
Net revenues in Asset Management increased by $86.0 million or 22% and
pre-tax earnings increased $29.2 million or 28% over the prior year's
period, principally as a result of the addition of $79.8 million of net
revenues and $31.8 million of pre-tax earnings from Royce and PCM
(including an increase of $14.0 million in interest expense related to
the debt issued to finance the acquisitions). Revenue growth at our
fixed income institutional investment advisor was offset in part by
declines in fees from company-sponsored equity mutual funds and declines
in net revenues from our non-U.S. based investment advisors. In
addition, interest revenue decreased $4.4 million, primarily as a result
of lower average interest rates earned on firm investments. Included in
the prior year period is $2.3 million of interest earned on proceeds
from debt issued to finance acquisitions. The pre-tax profit margin
increased to 28% from 27%. Asset Management represented 42% of
consolidated net revenues for the nine months ended December 31, 2002,
an increase from 37% in the prior year's period.
Private Client:
Private Client net revenues for the nine months ended December 31, 2002
decreased $16.1 million or 3%, while pre-tax earnings increased by $14.0
million or 33%, over the prior year's period. Net revenues declined
primarily due to a decrease of $14.8 million in distribution fee
revenues on company-sponsored equity mutual funds. The pre-tax profit
margin increased to 13% from 9%. The improvements in net earnings and
profit margin are due to a decline in non-interest expenses, primarily
attributable to expense reduction initiatives implemented last year,
including consolidated branches, a reduced number of full-time
employees, and lower costs for communication services. Private Client
represented 39% of consolidated net revenues in December 2002, a
decrease from 44% in the prior year's period. Net interest profit in
Private Client decreased 16% to $37.1 million for the nine months ended
December 31, 2002, primarily due to a decline in interest earned on
customer margin account and firm investment balances, both of which
resulted from significantly lower average interest rates. These
decreases in interest revenue were offset in part by a decrease in
interest paid on customer credit account balances.
Capital Markets:
Capital Markets net revenues were $194.9 million, an increase of 10%
from $176.5 million, while pre-tax earnings were $39.8 million, an
increase of 34% from the prior year's period. The increase in net
revenues was attributable to higher institutional fixed income and
equity transaction volume and increases in municipal banking fees and
fixed income trading profits. These increases were partially offset by
a change in mark-to-market adjustments related to warrants acquired in
connection with private placements. The pre-tax profit margin increased
to 20% from 17%. Capital Markets represented 17% of consolidated net
revenues in both the nine months ended December 31, 2002 and 2001.
23
Other:
Other revenues consist principally of the results of our real estate
service business and unallocated corporate revenues and expenses. In the
nine months ended December 31, 2002, net revenues and pre-tax earnings
declined $0.8 million and $1.3 million, respectively, from the prior
year's period, reflecting a reduction in net interest profit and fees
from our mortgage banking subsidiary, partially offset by an impairment
charge related to private equity investments in the prior year period.
Consolidated Expenses
Compensation and benefits:
Compensation and benefits increased 5% to $677.7 million from $642.7
million in the prior year's period, primarily attributable to the
addition of expenses of PCM and Royce and higher profitability-based
incentive expense related to Asset Management activities. These
increases were offset in part by a decline in retail sales and
distribution fee commissions and reduced expenses due to a lower number
of Private Client employees.
Communications and technology:
Communications and technology expense declined 10% to $68.0 million from
$75.3 million in the prior year's period, primarily as a result of
decreased costs for consulting fees and leased computer equipment.
Occupancy:
Occupancy was $49.2 million, up 6% from $46.2 million in the prior
year's period, primarily due to the addition of expenses of acquired
entities, higher operating expenses at our corporate headquarters and
additional space occupied by our fixed income institutional investment
advisor.
Amortization of intangible assets:
Amortization of intangible assets increased to $18.8 million for the
nine months ended December 31, 2002 from $12.6 million in the prior
year, primarily as a result of $5.5 million related to amortization of
asset management contracts acquired in the PCM acquisition.
Other:
Other expenses decreased 2% to $100.5 million from $102.0 million in the
prior year's period, primarily as a result of a decline in litigation
related expenses of approximately $6.1 million, offset in part by an
increase in expenses from commissions paid to third party distributors
of Royce funds and an increase of $1.9 million for expenses related to
advances to financial advisors.
Income tax provision:
The provision for income taxes increased 24% to $87.2 million, from
$70.5 million in the prior year's period, primarily as a result of the
24
increase in pre-tax earnings. The effective tax rate declined to 38.0%
in the nine months ended December 31, 2002 from 39.7% in the prior
year's period due to lower state income taxes, $2.0 million in one-time
net state income tax refunds and a lower effective foreign tax rate.
Business Segments
We allocate certain common income and expense items among our business
segments based upon various methodologies and factors. These
methodologies are by their nature subjective and are reviewed
periodically by management. Business segment results in the future may
reflect reallocations of revenues and expenses that result from changes
in methodologies, but any reallocations will have no effect on our
consolidated results of operations.
Liquidity and Capital Resources
The primary objective of our capital structure and funding practices is
to appropriately support Legg Mason's business strategies, as well as
the regulatory capital requirements of our subsidiaries, and to provide
needed liquidity at all times. Liquidity and the access to liquidity are
essential to our on-going operations. For a further discussion of our
principal liquidity and capital resources policies, see our Annual
Report on Form 10-K for the fiscal year ended March 31, 2002.
Except for the use of Legg Mason's short-term credit facilities to
finance a compensating balance arrangement described below, and the
increase in stockholder's equity from the results of operations for the
nine months ended December 31, 2002, there has been no material change
in our financial condition since March 31, 2002. Excess cash is
typically invested primarily in institutional money market funds or
securities purchased under agreements to resell.
At December 31, 2002, Legg Mason had an outstanding borrowing of $112.2
million under a compensating balance arrangement. The proceeds of the
borrowing were used to purchase short-term, highly liquid securities.
These securities are pledged as collateral for the credit facility and,
due to their characteristics, are classified as cash equivalents on our
December 31, 2002 Statement of Financial Condition. As the securities
mature, the cash proceeds are used to pay-down the outstanding balance
of the credit facility or to purchase additional securities, which are
then pledged as collateral for the borrowing. In addition, from time to
time, we may borrow from our committed, unsecured revolving credit
facility for short-term general corporate purposes.
Legg Mason's assets consist primarily of cash and cash equivalents,
collateralized short-term receivables, investment advisory fee
receivables, securities owned and borrowed, intangible assets and
goodwill. Our assets are principally funded by payables to customers,
securities loaned, bank loans, long-term debt and equity.
At December 31, 2002, Legg Mason's total assets and stockholders' equity
were $6.2 billion and $1.2 billion, respectively. During the nine months
ended December 31, 2002, cash and cash equivalents increased $356.7
million. Cash flows from operating activities provided approximately
$299.9 million, primarily attributable to an increase in net customer
payables and net earnings adjusted for depreciation and amortization,
25
offset in part by an increase in cash and securities segregated for
regulatory purposes. Cash flows from investing activities provided
$62.2 million, which included proceeds from sales and maturities of
investment securities, offset in part by purchases of investment
securities and payments for equipment and leasehold improvements.
Financing activities used $6.5 million, as a result of the repayment of
notes payable of finance subsidiaries and the repurchase of common
stock, partially offset by an increase in short-term borrowings, net of
repayments, as described above. During the nine months ended December
31, 2002, we repurchased 708,800 shares of our stock for $33.4 million
and we paid cash dividends of $20.8 million.
Our broker-dealer subsidiaries are subject to the requirements of the
Securities and Exchange Commission's Uniform Net Capital Rule, which is
designed to measure the general financial soundness and liquidity of
broker-dealers. As of December 31, 2002, the broker-dealer subsidiaries
had aggregate net capital of $331.2 million, which exceeded minimum net
capital requirements by $311.5 million. The amount of the broker-
dealers' net assets that may be distributed is subject to restrictions
under applicable net capital rules.
Contractual and Contingent Obligations
Legg Mason has contractual obligations to make future payments in
connection with our short and long-term debt and non-cancelable lease
agreements. In addition, we may also be required to make contingent
payments under business purchase agreements if certain future events
occur.
The following table sets forth these contractual and contingent
obligations by fiscal year:
Remaining There-
(in millions) 2003 2004 2005 2006 2007 after Total
Contractual Obligations:
Short-term borrowings by
contract maturity $112.2 $ - $ - $ - $ - $ - $ 112.2
Long-term borrowings by
contract maturity (a) 30.7 264.0 - 100.0 - 425.0 819.7
Coupon interest on long-
term borrowings 17.6 35.2 35.2 35.2 31.9 43.0 198.1
Minimum rental commitments 17.1 60.5 50.3 42.1 36.6 115.9 322.5
Total Contractual
Obligations 177.6 359.7 85.5 177.3 68.5 583.9 1,452.5
Contingent Obligations:
Contingent payments related
to business acquisitions(b) 0.1 1.0 500.0 13.8 300.0 - 814.9
Total Contractual and
Contingent Obligations(c) $177.7 $360.7 $585.5 $191.1 $368.5 $583.9 $2,267.4
26
a) The amount reflected for long-term borrowings due in 2003 represents notes
payable of finance subsidiaries. This obligation will be funded by proceeds
from the related investments, which will mature in 2003. Payments in 2004
reflect amounts that may be due to holders of the zero coupon convertible
senior notes, which represents the accreted value on the earliest possible
date that the holders may require us to purchase the notes. Legg Mason has
the option to pay the purchase price in cash, shares of common stock or a
combination of both.
b) The amount of contingent payments reflected for any year represents the
maximum amount that could be payable at the earliest possible date under the
terms of business purchase agreements.
c) The table above does not include approximately $23.9 million in capital
commitments to investment partnerships in which Legg Mason is a limited
partner. These obligations will be funded, as required, through the end of
the commitment periods that range from 2003 to 2010. These capital commit-
ments also include $1.3 million of commitments to lend employees funds to
invest in one of these partnerships.
Critical Accounting Policies
Accounting policies are an integral part of the preparation of our
financial statements in accordance with accounting principles generally
accepted in the United States of America. Understanding these policies,
therefore, is a key factor in understanding the reported results of
operations and the financial position of Legg Mason. Certain critical
accounting policies require us to make estimates and assumptions that
affect the amounts of assets, liabilities, revenues and expenses
reported in the financial statements. Due to their nature, estimates
involve judgment based upon available information. Therefore, actual
results or amounts could differ from estimates and the difference could
have a material impact on our consolidated financial statements. During
the nine months ended December 31, 2002, except for the Collateralized
Debt Obligations ("CDO") described below, there were no material changes
to the matters discussed under the heading "Critical Accounting
Policies" in Part II, Item 7 of Legg Mason's Annual Report on Form 10-K
for the fiscal year ended March 31, 2002.
During the nine months ended December 31, 2002, one of our asset
management subsidiaries became the collateral manager of two CDOs.
These CDOs are investment vehicles for investors and issued, in total,
approximately $952 million of debt, which was used to acquire portfolios
consisting primarily of high quality asset-backed securities. Legg
Mason did not sell any assets to these CDOs. For our services as
collateral manager, we are entitled to receive senior management fees
and may be eligible under certain circumstances to receive subordinated
management fees. We may be removed as collateral manager under certain
conditions.
Currently, we do not own an equity interest in any of the CDOs. Other
than the derivative contract described at March 31, 2002, we have no
financial commitments or guarantees to the CDOs and the underlying debt
is non-recourse to us as collateral manager. As such, these CDOs are
not consolidated. Our maximum exposure to loss as collateral manager at
December 31, 2002 is the loss of management fees earned but unpaid,
which approximates $0.5 million. We have also recorded an unrealized
27
loss of $3.0 million at December 31, 2002 related to the derivative
contract.
All of the CDOs described above are Special Purpose Entities and are
likely to qualify as Variable Interest Entities ("VIEs") under FASB
Interpretation Number ("FIN") 46, "Consolidation of Variable Interest
Entities - an interpretation of ARB No. 51" as described in the
"Recent Accounting Developments" section of this 10-Q. We have adopted
the disclosure requirements of FIN 46 for the CDOs and are in the
process of evaluating the impact of the remaining provisions of FIN 46,
which become effective in our quarter ending September 30, 2003. In
addition, in the normal course of our business activities we become the
general partner and in some cases a limited partner in investment
partnerships and the investment manager and/or managing member in limited
liability companies and we are currently evaluating the impact of FIN 46
on these entities.
Forward-Looking Statements
Legg Mason has made in this report, and from time to time may otherwise
make in its public filings, press releases and statements by Company
management, "forward-looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995 concerning Legg Mason's
operations, economic performance and financial condition. The words or
phrases "can be", "may be", "expects", "may affect", "may depend",
"believes", "estimate", "project" and similar words and phrases are
intended to identify such forward-looking statements. Such forward-
looking statements are subject to various known and unknown risks and
uncertainties and Legg Mason cautions readers that any forward-looking
information provided by or on behalf of Legg Mason is not a guarantee of
future performance. Actual results could differ materially from those
anticipated in such forward-looking statements due to a number of
factors, some of which are beyond Legg Mason's control, in addition to
those discussed elsewhere herein, in Legg Mason's Annual Report on Form
10-K for the fiscal year ended March 31, 2002 under the heading
"Business-Factors Affecting the Company and the Financial Services
Industry," and in Legg Mason's other public filings, press releases and
statements by Company management, including (i) the volatile and
competitive nature of the financial services business, (ii) changes in
domestic and foreign economic and market conditions, including, without
limitation, the duration and severity of the current difficult
conditions in the equity markets and in the domestic economy, (iii) the
effect of federal, state and foreign regulation on Legg Mason's
business, including, without limitation, the effects that the current
regulatory proceedings and investigations into research analyst
conflicts in the financial services industry may have on Legg Mason's
investment banking, institutional sales or retail brokerage businesses,
all of which have historically received support from Legg Mason's equity
research department, the effects on the Company of the current brokerage
industry-wide regulatory inquiry into whether retail customers have
received the full benefit of available reductions in mutual fund load
fees and the effects of the performance and potential regulatory issues
in the investment trust business in the United Kingdom, (iv) market,
credit and liquidity risks associated with Legg Mason's investment
management, underwriting, securities trading and market-making
activities, (v) impairment of acquired intangible assets and goodwill,
(vi) potential restrictions on the business of, and withdrawal of
28
capital from, certain subsidiaries of Legg Mason due to net capital
requirements, (vii) potential liability under federal and state
securities laws and other laws and regulations governing Legg Mason's
business, (viii) the relative investment performance of Legg Mason-
sponsored investment funds and other asset management products compared
with competing offerings and market indices, (ix) the ability of Legg
Mason to maintain investment management and administrative fees at
current levels, (x) the level of margin and customer account balances,
(xi) the ability to attract and retain key personnel and (xii) the
effect of acquisitions, including prior acquisitions. Due to such
risks, uncertainties and other factors, Legg Mason cautions each person
receiving such forward-looking information not to place undue reliance
on such statements. All such forward-looking statements are current
only as of the date on which such statements were made. Legg Mason does
not undertake any obligation to publicly update any forward-looking
statement to reflect events or circumstances after the date on which any
such statement is made or to reflect the occurrence of unanticipated
events.
Recent Accounting Developments
The following pronouncements have been issued by the Financial
Accounting Standards Board ("FASB") since March 31, 2002.
Statement of Financial Accounting Standards ("SFAS") No. 143,
"Accounting for Asset Retirement Obligations" requires the fair value of
a liability to be recorded for costs associated with the retirement of
tangible long-lived assets in the period in which the liability is
incurred if it can be reasonably estimated.
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets" supercedes SFAS No. 121, "Accounting for the Impairment of Long-
Lived Assets and for Long-Lived Assets to be Disposed Of." This
statement principally deals with implementation issues of SFAS No. 121,
including developing a single accounting model for long-lived assets to
be disposed of by sale.
SFAS No. 145, "Rescission of FASB Statements Nos. 4, 44 and 64,
Amendment of FASB Statement No. 13, and Technical Corrections as of
April 2002" primarily provides guidance for reporting gains and losses
from extinguishments of debt and sale-leaseback transactions.
SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities". This standard requires companies to recognize costs
associated with exit or disposal activities when they are incurred
rather than at the date of a commitment to an exit or disposal plan.
SFAS No. 146 replaces the existing guidance provided by EITF Issue No.
94-3, "Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (including Certain Costs Incurred in
a Restructuring)." SFAS No. 146 is to be applied prospectively to exit
or disposal activities initiated after December 31, 2002.
SFAS No. 147, "Acquisitions of Certain Financial Institutions - an
Amendment of FASB Statements No. 72 and 144 and FASB Interpretation No.
9". This statement provides guidance on the accounting for the
acquisition of a financial institution, which had previously been
addressed in SFAS No. 72, "Accounting for Certain Acquisitions of
29
Banking or Thrift Institutions," and requires that those transactions be
accounted for in accordance with SFAS No. 141, "Business Combinations",
and SFAS No. 142, " Goodwill and Other Intangible Assets." In addition,
this statement amends SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," to include long-term customer-
relationship intangible assets, other than those with indefinite lives,
and would require these assets to be subject to an undiscounted cash
flow recoverability impairment test that SFAS No. 144 requires for other
long-lived assets that are held and used.
SFAS No. 148 "Accounting for Stock-Based Compensation - Transition and
Disclosure - an amendment of FASB Statement No. 123" amends SFAS No.
123, "Accounting for Stock-Based Compensation". SFAS 148 provides
alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee
compensation. SFAS 148 also amends SFAS 123 to require prominent
disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the
effect of the method used on reported results. The disclosure
requirements of SFAS 148 are effective for Legg Mason's March 31, 2003
financial statements and interim periods thereafter.
FIN 45 "Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others -
an interpretation of FASB Statements No. 5, 57 and 107 and rescission
of FASB Interpretation No. 34" expands the disclosure requirements to
be made by a guarantor in its interim and annual financial statements
regarding its obligations under certain guarantees that it has issued.
FIN 45 also requires, under certain circumstances, the recognition, at
the inception of a guarantee, of a liability for the fair value of the
obligation as a result of issuing the guarantee. Guarantees of an
entity's own future performance are not within the scope of FIN 45.
FIN 46 requires the consolidation of the assets, liabilities and
results of operations of variable interest entities by the primary
beneficiary. FIN 46 also requires the disclosure of information
concerning variable interest entities by entities that hold
significant variable interests but may not be the primary beneficiary.
FIN 46 applies immediately to variable interest entities created after
January 31, 2003 and is effective for interim periods beginning after
June 15, 2003 for interests in variable interest entities that were
acquired before February 1, 2003. FIN 46 also requires the disclosure
of the nature, purpose, size and activities of variable interest
entities, as well as Legg Mason's maximum exposure to loss in
connection with VIE's for any financial statements issued after
January 31, 2003 if it is reasonably possible that an entity will
consolidate or disclose information about a VIE when FIN 46 becomes
effective.
During the nine months ended December 31, 2002, SFAS Nos. 143, 144,
145, 146 and 147 became effective and did not materially impact the
consolidated financial statements. We have adopted the disclosure
requirements of FIN 45 and 46 and are in the process of evaluating the
impact of the remaining provisions, which are effective in subsequent
30
periods. We will adopt the disclosure requirements of SFAS No. 148
for our March 31, 2003 financial statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
During the nine months ended December 31, 2002, there were no material
changes to the information contained in Part II, Item 7A of Legg Mason's
Annual Report on Form 10-K for the fiscal year ended March 31, 2002.
Item 4. Controls and Procedures
As of a date within 90 days of the filing of this Form 10-Q, Legg
Mason's management, including the Chief Executive Officer and the
Principal Financial Officer, evaluated the effectiveness of the design
and operation of Legg Mason's disclosure controls and procedures. Based
on that evaluation, Legg Mason's management, including its Chief
Executive Officer and its Principal Financial Officer, concluded that
Legg Mason's disclosure controls and procedures were effective in timely
alerting management, including the Chief Executive Officer and the
Principal Financial Officer, of material information about Legg Mason
required to be included in periodic Securities and Exchange Commission
filings. However, in evaluating the disclosure controls and procedures,
management recognized that any controls and procedures, no matter how
well designed and operated can provide only reasonable assurance of
achieving the desired control objectives, and management necessarily was
required to apply its judgment in evaluating the cost-benefit
relationship of possible controls and procedures. There have been no
significant changes in Legg Mason's internal controls or in other
factors that could significantly affect its internal controls subsequent
to the date of the evaluation.
31
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
3.1 Articles of Incorporation of Legg Mason,
as amended (incorporated by reference to
Form 10-Q for the quarter ended September
30, 2000)
3.2 By-laws of Legg Mason as amended and restated
April 25, 1988 (incorporated by reference to
Legg Mason's Annual Report on Form 10-K for
the year ended March 31, 1988)
12. Computation of consolidated ratios of
earnings to fixed charges
(b) No reports on Form 8-K were filed during the quarter
ended December 31, 2002.
32
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned thereunto duly authorized.
LEGG MASON, INC.
(Registrant)
DATE: February 13, 2003 /s/Timothy C. Scheve
Timothy C. Scheve
Senior Executive Vice President
DATE: February 13, 2003 /s/Charles J. Daley, Jr.
Charles J. Daley, Jr.
Senior Vice President and
Treasurer
33
CERTIFICATIONS
I, Raymond A. Mason, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Legg
Mason, Inc.;
2. Based on my knowledge, this quarterly report does not
contain any untrue statement of a material fact or omit to
state a material fact necessary to make the statements made,
in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report,
fairly present in all material respects the financial
condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules 13a-
14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
board of directors:
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant role in
the registrant's internal controls; and
34
6. The registrant's other certifying officer and I have
indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and
material weaknesses.
DATE: February 13, 2003 /s/Raymond A. Mason
Raymond A. Mason
Chairman, President and
Chief Executive Officer
35
I, Charles J. Daley, Jr., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Legg
Mason, Inc.;
2. Based on my knowledge, this quarterly report does not
contain any untrue statement of a material fact or omit to
state a material fact necessary to make the statements made,
in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report,
fairly present in all material respects the financial
condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules 13a-
14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
board of directors:
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant role in
the registrant's internal controls; and
36
6. The registrant's other certifying officer and I have
indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and
material weaknesses.
DATE: February 13, 2003 /s/Charles J. Daley, Jr.
Charles J. Daley, Jr.
Principal Financial Officer
37
INDEX TO EXHIBITS
3.1 Articles of Incorporation of Legg Mason,
as amended (incorporated by reference to
Form 10-Q for the quarter ended September
30, 2000)
3.2 By-laws of Legg Mason as amended and restated
April 25, 1988 (incorporated by reference to
the Company's Annual Report on Form 10-K for
the year ended March 31, 1988)
12. Computation of consolidated ratios of earnings
to fixed charges