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 June 30, 2003
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.
65,731,238 shares of common stock and 2,124,951 exchangeable shares as
of the close of business on July 29, 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.
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 ended
June 30,
2003 2002
Revenues
Investment advisory and related fees $ 241,825 $ 222,348
Commissions 84,306 84,828
Principal transactions 42,946 36,235
Investment banking 31,467 31,535
Interest 22,580 29,540
Other 17,026 12,891
Total revenues 440,150 417,377
Interest expense 16,811 24,953
Net revenues 423,339 392,424
Non-Interest Expenses
Compensation and benefits 245,728 234,814
Communications and technology 23,048 22,660
Occupancy 16,709 15,979
Amortization of intangible assets 5,992 6,318
Other 36,804 32,295
Total non-interest expenses 328,281 312,066
Earnings Before Income Tax Provision 95,058 80,358
Income tax provision 36,692 31,340
Net Earnings $ 58,366 $ 49,018
Earnings per Common Share
Basic $ 0.88 $ 0.74
Diluted 0.83 0.71
Weighted Average Number of Common
Shares Outstanding
Basic 66,173 65,938
Diluted 70,125 69,054
Dividends Declared per Common Share $ 0.11 $ 0.10
Book Value per Common Share,
at end of period $ 19.58 $ 16.88
See notes to consolidated financial statements.
3
LEGG MASON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in thousands)
June 30, 2003 March 31, 2003
(Unaudited)
Assets
Cash and cash equivalents $ 575,786 $ 690,752
Cash and securities segregated for
regulatory purposes or deposited with
clearing organizations 2,566,868 2,583,437
Securities purchased under agreements
to resell - 35,000
Receivables:
Customers 1,052,508 933,970
Investment advisory and related fees 140,683 121,209
Brokers and dealers 77,737 62,488
Others 39,094 36,854
Securities borrowed 311,617 255,230
Trading assets, at fair value 233,666 163,462
Investment securities, at fair value 55,915 42,519
Equipment and leasehold improvements, net 68,765 69,814
Intangible assets, net 465,581 470,408
Goodwill 460,205 454,512
Other 160,656 147,795
Total Assets $6,209,081 $6,067,450
Liabilities and Stockholders' Equity
Liabilities
Payables:
Customers $3,267,010 $3,246,285
Brokers and dealers 69,906 75,017
Securities loaned 252,053 219,954
Short-term borrowings 58,675 29,478
Trading liabilities, at fair value 73,191 59,583
Accrued compensation 153,344 235,971
Other 221,497 166,452
Long-term debt 788,603 786,753
Total Liabilities 4,884,279 4,819,493
Commitments and Contingencies (Note 5)
Stockholders' Equity
Common stock 6,549 6,483
Shares exchangeable into common stock 8,153 8,736
Additional paid-in capital 377,434 357,622
Deferred compensation and officer note
receivable (32,895) (34,578)
Employee stock trust (113,033) (109,803)
Deferred compensation employee stock trust 113,033 109,803
Retained earnings 964,613 913,670
Accumulated other comprehensive income
(loss), net 948 (3,976)
Total Stockholders' Equity 1,324,802 1,247,957
Total Liabilities and Stockholders' Equity $6,209,081 $6,067,450
See notes to consolidated financial statements.
4
LEGG MASON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in thousands)
(Unaudited)
Three months ended
June 30,
2003 2002
Net Earnings $ 58,366 $ 49,018
Other comprehensive income (loss):
Foreign currency translation adjustment 5,033 5,007
Unrealized gains (losses) on investment
securities:
Unrealized holding losses arising during
the period (95) (291)
Reclassification adjustment for (gains)
losses included in net income (82) --
Net unrealized losses on investment
securities (177) (291)
Deferred losses on cash flow hedge -- (3,412)
Deferred income taxes 68 1,327
Total other comprehensive income 4,924 2,631
Comprehensive Income $ 63,290 $ 51,649
See notes to consolidated financial statements.
5
LEGG MASON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)
Three months ended
June 30,
2003 2002
Cash Flows from Operating Activities
Net earnings $ 58,366 $ 49,018
Non-cash items included in earnings:
Depreciation and amortization 13,489 13,815
Accretion and amortization of securities
discounts and premiums, net 1,858 1,945
Originated mortgage servicing rights (548) (319)
Deferred compensation 2,715 2,502
Unrealized (gains) losses on firm investments (817) 651
Other (175) 309
Deferred income taxes (2,455) 8,865
Purchases of trading investments, net (12,221) (2,217)
Decrease (increase) in assets excluding
acquisitions:
Cash and securities segregated for regulatory
purposes or deposited with clearing
organizations 16,569 70,635
Receivables from customers (118,538) 23,377
Receivables for investment advisory and
related fees (18,987) (517)
Receivables from brokers and dealers and other (17,274) (34,671)
Securities borrowed (56,387) 55,719
Trading assets (70,204) (118,543)
Other (11,242) (104)
Increase (decrease) in liabilities excluding
acquisitions:
Payable to customers 20,725 (69,601)
Payable to brokers and dealers (5,111) (17,770)
Securities loaned 32,099 (101,747)
Trading liabilities 13,608 57,261
Accrued compensation (83,390) (84,839)
Other 56,821 9,737
Cash Used for Operating Activities (181,099) (136,494)
Cash Flows from Investing Activities
Payments for:
Equipment and leasehold improvements (5,667) (8,120)
Acquisitions, net of cash acquired (2,702) --
Net decrease in securities purchased under
agreements to resell 35,000 --
Purchases of investment securities (4,785) (3,355)
Proceeds from sales and maturities of
investment securities 4,886 8,967
Cash Provided by (Used for) Investing Activities 26,732 (2,508)
6
LEGG MASON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(continued)
(Dollars in thousands)
(Unaudited)
Three months ended
June 30,
2003 2002
Cash Flows from Financing Activities
Net increase in short-term borrowings 29,197 156,433
Issuance of common stock 16,322 8,089
Repurchase of common stock -- (8,090)
Dividends paid (7,374) (6,695)
Cash Provided by Financing Activities 38,145 149,737
Effect of Exchange Rate Changes on Cash 1,256 899
Net Increase (Decrease) in Cash and Cash
Equivalents (114,966) 11,634
Cash and Cash Equivalents at Beginning of Period 690,752 468,377
Cash and Cash Equivalents at End of Period $575,786 $480,011
SUPPLEMENTARY DISCLOSURE:
Noncash activity:
The value of common stock issued in connection with a business acquisition
was $3,262 for the quarter ended June 30, 2002. Of that amount, $1,783 was
attributable to goodwill, $1,416 was attributable to intangible assets and
$63 was attributable to tangible net assets.
See notes to consolidated financial statements.
7
LEGG MASON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
June 30, 2003
(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 using 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 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 preparation of interim consolidated financial statements requires
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. Trading Assets, at Fair Value
At June 30, 2003, Legg Mason had pledged securities owned of $294 as
collateral to counterparties for securities loaned transactions, which can
be sold or repledged by the counterparties.
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3. Intangible Assets and Goodwill
The following table reflects the components of intangible assets
as of:
June 30, 2003 March 31, 2003
Amortized Intangible Assets, Cost
Asset management contracts $ 352,500 $ 351,714
Mortgage servicing contracts 11,291 10,743
Total $ 363,791 $ 362,457
Amortized Intangible Assets,
Accumulated Amortization
Asset management contracts $ (52,847) $ (46,900)
Mortgage servicing contracts (4,747) (4,317)
Total $ (57,594) $ (51,217)
Indefinite-Life Intangible Assets
Fund management contracts $ 104,684 $ 104,468
Trade name 54,700 54,700
Total $ 159,384 $ 159,168
Estimated amortization expense for each of the next five fiscal
years is as follows:
Fiscal year ended March 31: Amount
Remaining 2004 $ 17,578
2005 22,047
2006 21,754
2007 21,289
2008 19,623
2009 19,214
The carrying value of goodwill of $460,205 at June 30, 2003 is
primarily attributable to Legg Mason's asset management reporting segment.
The increase in the carrying value of goodwill since March 31, 2003 primarily
reflects approximately $3,235 from the impact of changes in foreign currency
exchange rates, approximately $1,915 related to an increase in ownership
interest in Barrett Associates, Inc. and approximately $543 related to a
subsequent contingent payment in connection with the acquisition of the
assets of an investment advisor which was not material to Legg Mason's
financial statements.
4. Short-Term Borrowings
At June 30, 2003, Legg Mason had an outstanding borrowing of $37,037
under a compensating balance arrangement. The proceeds of the borrowing were
used to purchase short-term, highly liquid securities, which are pledged as
collateral for the credit facility and are classified as cash equivalents on
9
the June 30, 2003 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, on June 30, 2003, Legg Mason
borrowed $20,000, on an overnight basis, to facilitate customer transaction
settlements.
Legg Mason also had a security sold under agreement to repurchase of
$1,638 at June 30, 2003, with an interest rate of 1.12%, that matured on
July 1, 2003.
5. 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 2018. Certain leases provide for renewal options and contain
escalation clauses providing for increased rentals based upon maintenance,
utility and tax increases.
As of June 30, 2003, the minimum annual aggregate rentals are
as follows:
Remaining 2004 $ 46,190
2005 54,220
2006 46,595
2007 41,133
2008 36,859
Thereafter 102,024
Total $ 327,021
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 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 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.
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.
10
The following table presents the computations of basic and diluted EPS:
Three months ended June 30,
2003 2002
Basic Diluted Basic Diluted
Weighted average common
shares outstanding 66,173 66,173 65,938 65,938
Potential common shares:
Employee stock options -- 3,345 -- 2,576
Shares related to
deferred compensation -- 607 -- 540
Weighted average common and
common equivalent shares
outstanding 66,173 70,125 65,938 69,054
Net earnings applicable
to common stock $58,366 $58,366 $49,018 $49,018
Earnings per common share $ 0.88 $ 0.83 $ 0.74 $ 0.71
As discussed in Legg Mason's Annual Report on Form 10-K for the fiscal
year ended March 31, 2003, the zero-coupon contingent convertible senior notes
contain conversion features which are triggered by certain events, including
the sale price of Legg Mason's common stock reaching specified thresholds. If
the closing sale price of Legg Mason's common stock for at least 20 trading
days in any period of 30 consecutive trading days ending on the last trading
day of a calendar quarter is more than a specified conversion price, then
commencing on the first day of the following quarter, holders may convert
their convertible notes into shares of common stock. For the quarters ended
September 30 and December 31, 2003, the conversion prices are $72.70 and
$73.15, respectively. At July 29, 2003, the closing sale price of Legg
Mason's common stock was $69.49. If the senior notes are converted into
shares of common stock, approximately 4.4 million shares will be included in
diluted earnings per share at the beginning of the quarter in which the
conditions are met, and will reduce diluted earnings per share for the
quarter by approximately $0.03.
7. Stock Based Compensation
Legg Mason's stock-based compensation plans include stock options,
stock purchase plans, restricted stock awards and deferred compensation and
retention bonuses payable in stock. Legg Mason accounts for stock-based
compensation in accordance with Accounting Principles Board Opinion ("APB")
No. 25, "Accounting for Stock Issued to Employees" as permitted by SFAS No.
123, "Accounting for Stock-Based Compensation," as amended. In accordance
with APB No. 25, compensation expense is not recognized for stock options
that have no intrinsic value (the exercise price is not less than the market
price) on the date of grant.
11
The following table reflects pro forma results as if compensation
expense associated with option grants and the stock purchase plan is
recognized over the vesting period:
Three Months Ended,
June 30,
2003 2002
Net Earnings, as reported $ 58,366 $ 49,018
Less: stock-based compensation,
net of taxes (5,080) (5,121)
Pro forma net earnings $ 53,286 $ 43,897
Earnings per share:
As reported:
Basic $ 0.88 $ 0.74
Diluted 0.83 0.71
Pro forma:
Basic $ 0.81 $ 0.67
Diluted 0.76 0.64
The weighted average fair value of stock options granted in the
three months ended June 30, 2003 and 2002 estimated using the Black-Scholes
option-pricing model, was $20.76 and $20.82 per share, respectively.
The following weighted average assumptions were used in the model
for grants.
Three Months Ended
June 30,
2003 2002
Expected dividend yield 0.82 % 0.82 %
Risk-free interest rate 3.34 % 4.95 %
Expected volatility 35.51 % 33.90 %
Expected lives (in years) 6.51 6.62
8. 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 June 30, 2003, the broker-
dealer subsidiaries had aggregate net capital, as defined, of $345,202,
which exceeded required net capital by $322,342.
12
9. Recent Accounting Developments
The Financial Accounting Standards Board ("FASB") has issued the
following pronouncements since March 31, 2003.
In April 2003, the FASB issued Statement of Financial Accounting
Standards ("SFAS") No. 149, "Amendment of Statement 133 on Derivative
Instruments and Hedging Activities." SFAS No. 149 amends and clarifies the
accounting for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities. In addition, the
statement clarifies when a contract is a derivative and when a derivative
contains a financing component that warrants special reporting in the
statement of cash flows. SFAS No. 149 is generally effective prospectively
for contracts entered into or modified, and hedging relationships designated,
after June 30, 2003. Legg Mason does not expect adoption to materially impact
the consolidated financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity."
SFAS No. 150 establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity, and imposes certain additional disclosure requirements. The provisions
of SFAS No. 150 are generally effective for financial instruments entered into
or modified after May 31, 2003. Legg Mason must apply the provisions of SFAS
No. 150 to all financial instruments at the beginning of its second quarter of
fiscal 2004. Legg Mason does not expect adoption to materially impact the
consolidated financial statements.
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
utilized. Certain services that Legg Mason offers are provided to clients
through more than one of its business segments. As such, the same revenue
category may be reflected in multiple 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 any reallocations will have no effect on Legg
Mason's consolidated results of operations.
The Asset Management segment provides asset management services to
institutional and individual clients and investment advisory services to
company-sponsored investment funds. 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 exceeding performance
benchmarks. Distribution fees earned on company-sponsored investment funds
are reported in Private Client when sold through its branch distribution
network.
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.
The primary sources of net revenues for Private Client are commissions and
principal credits earned on equity and fixed income transactions in customer
brokerage accounts,
13
distribution fees earned from mutual funds, fees earned from 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, corporate and public finance advisory
and underwriting activities, as well as corporate structured financing
activities. Fixed income institutional sales and trading include transactions
in both corporate and municipal products. Although Legg Mason maintains
securities in inventory primarily to facilitate customer transactions, Capital
Markets also realizes trading profits and losses from trading 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 and investment banking
activities.
The Other segment consists principally of Legg Mason's real estate
service and mortgage banking business and unallocated corporate revenues and
expenses. See Note 11 of Notes to Consolidated Financial Statements for
discussion of the subsequent sale of Legg Mason's commercial mortgage banking
and mortgage servicing operations.
Business segment financial results are as follows:
Three months ended
June 30,
2003 2002
Net revenues:
Asset Management $188,861 $163,187
Private Client 158,744 156,152
Capital Markets 68,275 66,240
Other 7,459 6,845
Total $423,339 $392,424
Earnings (loss) before income
tax provision:
Asset Management $ 54,805 $ 46,296
Private Client 28,355 21,486
Capital Markets 12,263 13,273
Other (365) (697)
Total $ 95,058 $ 80,358
Legg Mason does not analyze asset information in all business
segments.
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Legg Mason principally operates in the United States of America, the
United Kingdom and Canada. Revenues and expenses for geographic purposes are
generally allocated based on the location of the office providing the service.
Results by geographic region are as follows:
Three months ended
June 30,
2003 2002
Net revenues:
United States $401,196 $373,900
United Kingdom 12,757 9,549
Canada 6,637 6,687
Other 2,749 2,288
Total $423,339 $392,424
Earnings (loss) before income tax
provision:
United States $ 91,172 $ 78,116
United Kingdom 1,056 (1,367)
Canada 1,824 2,773
Other 1,006 836
Total $ 95,058 $ 80,358
11. Subsequent Events
In July 2003, Legg Mason entered into an agreement to sell assets
comprising the commercial mortgage banking and mortgage servicing operations
of its wholly owned subsidiary, Legg Mason Real Estate Services, Inc.
("LMRES"). LMRES will continue to operate its real estate investment advisory
business. The sales price for the assets is $23,100, subject to potential
pricing adjustments, including $16,200 in cash at closing and $6,900 in a
non-interest bearing note due four years from closing. Based on the estimated
present value of the sales price, Legg Mason expects to record a gain, net of
transaction costs, of approximately $11.0 million ($6.6 million, net of tax).
The completion of the sale, which is anticipated to occur in the September
quarter, is subject to customary closing conditions.
At June 30, 2003, the total assets and liabilities of LMRES that were
sold were $52,092 and $38,580, respectively, and were primarily made up of
mortgages held for sale, cash equivalents, intangible assets, short-term
borrowings and accrued liabilities. The net revenues and pre-tax losses of
the operations that were sold, which are included in the Other segment, were
$5,942 and $354, respectively, for the quarter ended June 30, 2003, and $5,859
and $257, respectively, for the quarter ended June 30, 2002, after elimination
of intercompany transactions.
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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, 2003.
Terms such as "we," "us," "our," and "company" refer to Legg Mason.
Business Environment
The weak U.S. equity market conditions experienced in the prior two fiscal
years improved during the first quarter of fiscal 2004, although uncertainty
in the economic outlook remained. The Dow Jones Industrial Average, the Nasdaq
Composite Index and the S&P 500 were up 12%, 21% and 15%, respectively. The
fixed income markets continued to benefit during the quarter from declining
interest rates and the volatility of the equity markets. During the quarter,
the U.S. Federal Reserve lowered interest rates by 0.25% to 1.00%, the lowest
level in 45 years.
Results of Operations
The results of operations for the June 30, 2003 quarter were very strong for
Legg Mason as we set records in net revenues, net earnings and earnings per
share. Compared to the quarter ended June 30, 2002, net revenues increased
8% to $423.3 million, primarily due to increased fees from asset management
and institutional taxable fixed income activities. Net earnings increased
19% to $58.4 million. Diluted earnings per share were $0.83, an increase of
17% from $0.71. Assets under management increased 22% to $216.6 billion.
Included in this increase is $1.2 billion resulting from a definitional change
according to which we added certain assets of joint ventures that we had
previously excluded. The pre-tax profit margin increased to 22.5% from 20.5%,
primarily due to an increase in revenues and a lower effective incentive
compensation payout rate. Compared to the quarter ended March 31, 2003, net
revenues and net earnings increased 10% and 20%, respectively, and diluted
earnings per share were up 17% from $0.71. Assets under management increased
13% from $192.2 billion.
Quarter Ended June 30, 2003 Compared to Quarter Ended June 30, 2002
Net Revenues
Investment advisory and related fees, including distribution fees from
investment funds, increased 9% to $241.8 million, primarily as a result of
$18.8 million in combined growth from Western Asset Management Company and
Western Asset Management Company Ltd. (combined, "Western Asset"), our
primary fixed income manager and Private Capital Management, LP ("PCM"),
our largest wealth
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manager. Investment advisory and related fees represented 57.1% of
consolidated net revenues, up slightly from 56.7% in the prior year's quarter.
Securities brokerage revenues, including both commissions and principal
transactions, increased 5% to $127.3 million primarily as a result of an
increase in the volume of institutional taxable fixed income transactions.
Investment banking revenues were $31.5 million, relatively unchanged from the
prior year's quarter. Increases in retail selling concessions and public
finance fees were offset by a decline in corporate advisory revenue and
institutional selling concessions. Other revenues increased 32% to $17.0
million, primarily as a result of realized and unrealized gains on firm
investments in the current quarter, along with unrealized losses in the
prior year's quarter.
Despite a decrease of $5.1 million in both interest revenues and expenses
due to lower interest rates, net interest profit increased 26% to $5.8
million, primarily as a result of an increase in revenues of $0.9
million due to higher firm investment balances. In addition, interest
revenue and expense both declined $2.4 million due to the maturity of
finance subsidiary investments and notes payable in the prior year. The
current quarter's net interest profit margin increased to 26% from 16% and
net interest profit accounted for 6% of consolidated pre-tax profits,
unchanged from the prior year's quarter.
Non-Interest Expenses
Compensation and benefits increased 5% to $245.7 million, primarily due to
increases in profitability-based incentive expense and increased salaries at
Western Asset resulting from an increase in the number of full-time employees.
However, compensation as a percentage of net revenues decreased to 58.0% from
59.8% in the prior year's quarter, which resulted from increased revenues and
lower effective incentive compensation payout rates.
Communications and technology expense increased 2% to $23.0 million, primarily
as a result of increased technology costs.
Occupancy increased 5% to $16.7 million, primarily due to expenses accrued
related to the consolidation of certain office locations.
Amortization of intangible assets declined 5% to $6.0 million, primarily as a
result of fully amortized asset management contracts.
Other expenses increased 14% to $36.8 million, primarily due to increases in
third-party commissions on sales of offshore funds, professional fees and a
contribution of $1.5 million to our charitable foundation trust.
The provision for income taxes increased 17% to $36.7 million, as a result of
the increase in pre-tax earnings. The effective tax rate declined to 38.6%
from 39.0% in the prior year's quarter due to a lower average effective
foreign tax rate.
17
Results By Segment
Asset Management
Three months ended June 30,
(in millions) 2003 2002
Net revenues $ 188.9 $ 163.2
Non-interest expenses 134.1 116.9
Pre-tax earnings $ 54.8 $ 46.3
Profit margin 29.0% 28.4%
Net revenues in Asset Management increased 16% to $188.9 million and pre-tax
earnings increased 18% to $54.8 million, principally as a result of increased
investment advisory revenues, resulting from higher assets under management
at Western Asset and PCM, which together accounted for $18.8 million of the
increase in net revenues. In addition, higher commissions at PCM's brokerage
operations and unrealized gains on firm investments also contributed to the
increase in net revenues. Compensation as a percentage of net revenues was
47.5% in June 2003 and 47.7% in June 2002. The pre-tax profit margin increased
to 29.0% from 28.4% in the prior year's quarter as a result of higher revenues
generated at subsidiaries that retain a lower percentage of revenues under
revenue-sharing agreements. Asset Management represented 44.6% of consolidated
net revenues at June 2003, an increase from 41.6% in the prior year's quarter.
Total assets under management were $216.6 billion as of June 30, 2003, an
increase of $38.9 billion or 22% from June 30, 2002. As of June 30, 2003,
approximately $139.6 billion or 64.5% of assets under management were in
fixed income related products and approximately $77.0 billion or 35.5% were
in equity related products. Our assets under management mix was as follows:
Institutional - $147.9 billion (68.3%); Mutual Funds - $44.9 billion (20.7%);
and Wealth Management - $23.8 billion (11.0%). Net revenues by division within
Asset Management for the quarter ended June 30, 2003 were as follows:
Institutional - $96.2 million; Mutual Funds - $55.2 million; and Wealth
Management - $37.5 million.
Private Client
Three months ended June 30,
(in millions) 2003 2002
Net revenues $ 158.7 $ 156.2
Non-interest expenses 130.3 134.7
Pre-tax earnings $ 28.4 $ 21.5
Profit margin 17.9% 13.8%
Private Client net revenues increased slightly to $158.7 million from $156.2
million for the prior year's quarter, primarily as a result of an increase in
corporate selling concessions, offset by a reduction in fee-based brokerage,
managed accounts and distribution fees, and the impact of the prior year's
sale of contracts in our bank brokerage network. Compensation as a percentage
of net revenues declined
18
to 58.2% in June 2003 from 59.9% in June 2002, primarily due to lower
commission rates paid on company-sponsored mutual fund distribution fees and
the elimination of bank brokerage commissions. The pre-tax profit margin
increased to 17.9% from 13.8% in the prior year's quarter, as a result of
higher revenues combined with reduced compensation expenses and the impact
of continued cost savings. Private Client represented 37.5% of consolidated
net revenues in June 2003, a decrease from 39.8% in the prior year's quarter.
Capital Markets
Three months ended June 30,
(in millions) 2003 2002
Net revenues $ 68.3 $ 66.2
Non-interest expenses 56.0 52.9
Pre-tax earnings $ 12.3 $ 13.3
Profit margin 18.0% 20.0%
Capital Markets net revenues of $68.3 million increased 3% from $66.2 million
in the prior year's quarter. Higher institutional fixed income and equity
transaction volume and an increase due to the prior year quarter's unrealized
losses on warrants acquired in connection with private placements, were offset
in part by declines in corporate banking activity, primarily new issue selling
concessions and advisory fees. Compensation as a percentage of net revenues
declined to 56.8% in June 2003 from 57.3% in June 2002 primarily as a result
of lower effective incentive compensation arrangements on increased revenues.
The pre-tax profit margin decreased to 18.0% from 20.0% in the prior year's
quarter as a result of increased allocated support costs and higher technology
costs. Capital Markets represented 16.1% of consolidated net revenues for the
quarter ended June 30, 2003, a decrease from 16.9% in the prior year's
quarter.
Other
Three months ended June 30,
(in millions) 2003 2002
Net revenues $ 7.4 $ 6.8
Non-interest expenses 7.8 7.5
Pre-tax earnings $ (0.4) $ (0.7)
Profit margin (4.9)% (10.2)%
Other consists principally of the results of our real estate service and
mortgage banking business and unallocated corporate revenues and expenses.
Net revenues and pretax earnings increased 9% to $7.4 million and 48% to
$(0.4) million, respectively, from the corresponding prior year period,
driven by fees earned from the acquisition of real estate for a managed
portfolio and lower corporate overhead allocations.
19
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 certain of our subsidiaries, and to provide
needed liquidity at all times. Liquidity and the access to liquidity are
essential to the success of our ongoing 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, 2003.
Except for the use of Legg Mason's short-term credit facilities described
below and the increase in stockholders' equity from the results of operations
for the quarter ended June 30, 2003, there has been no material change in our
financial condition since March 31, 2003. Excess cash is typically invested
primarily in institutional money market funds or securities purchased under
agreements to resell.
During the quarter ended June 30, 2003, Legg Mason arranged a new three-year,
committed, unsecured $100 million credit facility, which replaced a similar
$100 million facility which expired in June. The facility has restrictive
covenants that require Legg Mason, among other things, to maintain specified
levels of net worth and debt-to-equity ratios. Legg Mason intends to use the
facility for general corporate purposes that may include short-term funding
needs.
At June 30, 2003, Legg Mason had an outstanding borrowing of $37.0 million
under a compensating balance arrangement. The proceeds of the borrowing were
used to purchase short-term, highly liquid securities which are pledged as
collateral for the credit facility and are classified as cash equivalents on
our June 30, 2003 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, on June 30, 2003, Legg Mason
borrowed $20.0 million, on an overnight basis, to facilitate customer
transaction settlements.
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 June 30, 2003, Legg Mason's total assets and stockholders' equity were
$6.2 billion and $1.3 billion, respectively. During the three months ended
June 30, 2003, cash and cash equivalents decreased $115.0 million. Cash flows
from operating activities used approximately $181.1 million, primarily
attributable to an increase in net customer receivables, the payment of
accrued compensation costs and higher levels of firm net trading assets,
offset in part by net earnings adjusted for depreciation and amortization.
Cash flows from investing activities provided $26.7 million, which included a
net decrease in securities purchased under agreements to resell, offset in
part by payments for equipment and leasehold improvements and purchases of
investment securities. Financing activities provided $38.1 million, as a
result of an increase in short-term borrowings, net of repayments, as
described above, and issuance of
20
common stock resulting from stock option exercises. During the quarter
ended June 30, 2003, we paid cash dividends of $7.4 million ($0.11 per share).
On July 22, 2003, the Board of Directors approved a 36% increase in the
quarterly dividend to $0.15 per share. There were no share repurchases
during the quarter ended June 30, 2003.
In July 2003, we entered into an agreement to sell assets comprising the
commercial mortgage banking and mortgage servicing operations of our wholly
owned subsidiary, Legg Mason Real Estate Services, Inc. ("LMRES"). LMRES
will continue to operate its real estate investment advisory business. The
sales price for the assets was $23,100, subject to potential pricing
adjustments, including $16,200 in cash at closing and $6,900 in a non-interest
bearing note due four years from closing. The completion of the sale, which
is anticipated to occur in the September quarter, is subject to customary
closing conditions. The pre-tax earnings and cash flows from the operations
of LMRES are not material to our consolidated operations. See Note 11 of
Notes to Consolidated Financial Statements.
Under certain events, our zero-coupon contingent convertible senior notes
can become convertible into shares of our common stock. See Note 6 of Notes
to Consolidated Financial Statements for the potential negative impact on our
earnings per share.
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 June 30, 2003, the broker-dealer subsidiaries had
aggregate net capital of $345.2 million, which exceeded minimum net capital
requirements by $322.3 million. The amount of the broker-dealers' net assets
that may be distributed is subject to restrictions under applicable net
capital rules.
Contractual Obligations and Contingent Payments
Legg Mason has contractual obligations to make future payments in connection
with our short and long-term debt, non-cancelable lease agreements and a
forward purchase agreement. In addition, we may be required to make
contingent payments under business purchase agreements if certain future
events occur.
21
The following table sets forth these contractual and contingent
obligations by fiscal year:
Remaining There-
(In millions) 2004 2005 2006 2007 2008 after Total
Contractual Obligations
Short-term borrowings by
contract maturity $ 58.7 $ -- $ -- $ -- $ -- $ -- $ 58.7
Long-term borrowings by
contract maturity (a) -- -- 378.9 -- -- 425.0 803.9
Coupon interest on long-
term borrowings 35.2 35.2 31.9 28.7 28.7 14.3 174.0
Minimum rental commitments 46.2 54.2 46.6 41.1 36.9 102.0 327.0
Forward purchase
agreement (b) -- -- 4.2 -- -- -- 4.2
Total Contractual
Obligations 140.1 89.4 461.6 69.8 65.6 541.3 1,367.8
Contingent Obligations:
Contingent payments related
to business acquisitions(c) 0.4 500.0 6.8 300.0 -- -- 807.2
Total Contractual and
Contingent Obligations (d) $140.5 $589.4 $468.4 $369.8 $ 65.6 $541.3 $2,175.0
a) Included in the payments in 2006 is $278.9, reflecting amounts that may be
due to holders of the zero coupon convertible senior notes, which represents
the accreted value on the next possible date that the holders may require us
to purchase the notes. Legg Mason has the option to pay the purchase price
in cash or common stock or a combination of both.
b) See Note 1 of Notes to Consolidated Financial Statements, "Derivative
Instruments," contained in Legg Mason's Annual Report on Form 10-K for the
fiscal year ended March 31, 2003.
c) 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.
d) The table above does not include approximately $26.8 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 fiscal 2004 to 2011. These capital commitments also
include $1.3 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 quarter ended June 30, 2003, there were no material
changes to the
22
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, 2003.
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, including those
discussed elsewhere herein, in Legg Mason's Annual Report on Form 10-K for
the fiscal year ended March 31, 2003 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. 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 Financial Accounting Standards Board ("FASB") has issued the following
pronouncements since March 31, 2003.
In April 2003, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 149, "Amendment of Statement 133 on Derivative Instruments and
Hedging Activities." SFAS No. 149 amends and clarifies the accounting for
derivative instruments, including certain derivative instruments embedded
in other contracts, and for hedging activities. In addition, the statement
clarifies when a contract is a derivative and when a derivative contains a
financing component that warrants special reporting in the statement of cash
flows. SFAS No. 149 is generally effective prospectively for contracts
entered into or modified, and hedging relationships designated, after June
30, 2003. Legg Mason does not expect adoption to materially impact the
consolidated financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No.
150 establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity,
and imposes certain additional disclosure requirements. The provisions of
SFAS No. 150 are generally effective for financial instruments entered into
or modified after May 31, 2003. Legg Mason must apply the provisions of
SFAS No. 150 to all financial instruments at the beginning of our second
quarter of fiscal 2004. Legg Mason does not expect adoption to materially
impact the consolidated financial statements.
23
Item 3. Quantitative and Qualitative Disclosures About Market Risk
During the quarter ended June 30, 2003, 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, 2003.
Item 4. Controls and Procedures
As of June 30, 2003, 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 changes in Legg Mason's internal control over financial reporting
that occurred during the quarter ended June 30, 2003 that have materially
affected, or are reasonably likely to materially affect, Legg Mason's
internal control over financial reporting.
24
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
31.1 Certification of Chief Executive Officer
31.2 Certification of Principal Financial Officer
32.1 Certification of Chief Executive Officer
32.2 Certification of Principal Financial Officer
(b) A report on Form 8-K was filed on May 6, 2003 reporting under
Item 12. This report contained consolidated statements of
earnings for the quarters and fiscal years ended March 31, 2003
and 2002.
25
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: August 7, 2003 /s/Raymond A. Mason
Raymond A. Mason
Chairman, President and
Chief Executive Officer
DATE: August 7, 2003 /s/Charles J. Daley, Jr.
Charles J. Daley, Jr.
Senior Vice President and
Treasurer
26
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
31.1 Certification of Chief Executive Officer
31.2 Certification of Principal Financial Officer
32.1 Certification of Chief Executive Officer
32.2 Certification of Principal Financial Officer