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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended March 31, 1997
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 No. 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 Identification No.)
incorporation or organization)
111 South Calvert Street 21202
Baltimore, Maryland (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (410) 539-0000
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
Common Stock, $.10 par value New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 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 by check mark if disclosure of delinquent filers pursuant
to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy
or information statements incorporated by reference in Part III of
this Form 10-K or any amendment to this Form 10-K. [ ]
As of May 16, 1997, the aggregate market value of the registrant's
common stock held by non-affiliates was $750,052,000.
As of May 16, 1997, the number of shares outstanding of the
registrant's common stock was 18,303,307.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive proxy statement dated
June 13, 1997 are incorporated by reference into Part III.
1
Part I
Item 1. Business.
General
Legg Mason, Inc. is a holding company which, through
its subsidiaries, is engaged in securities brokerage and trading,
investment management of individual and institutional accounts
and Company-sponsored mutual funds, investment banking for
corporations and municipalities, commercial mortgage banking and
provision of other financial services.
The Company's principal broker-dealer subsidiary is Legg Mason
Wood Walker, Incorporated ("Legg Mason Wood Walker"), a full service
regional broker-dealer and investment banking firm operating primarily
in the Eastern and Mid-South regions of the United States. Another
broker-dealer subsidiary, Howard, Weil, Labouisse, Friedrichs
Incorporated ("Howard Weil"), engages primarily in energy-related
investment banking and institutional brokerage.
Investment advisory subsidiaries of the Company, and their
respective assets under management as of March 31, 1997, include
Legg Mason Fund Adviser, Inc., which serves as investment adviser
to or manager of Company-sponsored mutual funds, with assets of
approximately $7.1 billion; Western Asset Management Company, which
manages fixed-income assets for institutional accounts, with
approximately $24.6 billion under management; Batterymarch Financial
Management, Inc., which manages emerging markets, international and
U.S. equity portfolios for institutional clients, with approximately
$4.1 billion under management; Bartlett & Co., which serves as investment
adviser to high net worth individuals and institutions, with approximately
$2.4 billion under management; Legg Mason Capital Management, Inc.,
which serves as investment adviser to individual and institutional
accounts, with approximately $980 million under management; Gray,
Seifert & Co., Inc., which serves as investment adviser to wealthy
individual, family group, endowment and foundation accounts, with
approximately $950 million under management; Western Asset Global
Management Limited, which manages international fixed-income securities
and currencies, with approximately $2.1 billion under management; and
Fairfield Group, Inc., which serves as investment adviser to mutual
funds (with assets of approximately $210 million) structured to meet the
investment needs of banks and bank trust departments.
The Company's principal real estate finance subsidiaries are
Legg Mason Real Estate Services, Inc. and Legg Mason Dorman & Wilson,
Inc., which are primarily engaged in commercial mortgage banking and
commercial loan servicing.
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In the fiscal year ended March 31, 1997, the Company's total
revenues were derived approximately 44% from individual investor
brokerage accounts, including interest on margin accounts, 7% from
institutional investor brokerage accounts, 29% from investment
advisory services, and the balance from transactions as principal
with other dealers, investment banking, commercial mortgage banking
and other activities.
The Company was incorporated in Maryland in 1981 to serve as a
holding company for Legg Mason Wood Walker and other subsidiaries.
The predecessor company to Legg Mason Wood Walker was formed in 1970
under the name Legg Mason & Co., Inc. to combine the operations of
Legg & Co., a Maryland-based broker-dealer formed in 1899, and Mason
& Company, Inc., a Virginia-based broker-dealer formed in 1962.
The Company's subsequent growth has occurred through internal expansion
as well as through its acquisitions of broker-dealer, investment
management and commercial mortgage banking firms.
Unless the context otherwise requires, all references in this
Report to the Company include Legg Mason, Inc. and its predecessors
and subsidiaries.
Registrations and Exchange Memberships
Legg Mason Wood Walker and Howard Weil are registered as
broker-dealers with the Securities and Exchange Commission ("SEC"),
are members of the New York Stock Exchange, Inc. ("NYSE"), the
New York Futures Exchange, Inc., the National Association of
Securities Dealers, Inc. ("NASD") and the Securities Investors
Protection Corporation ("SIPC"), and are registered as futures
commission merchants with the Commodity Futures Trading Commission.
In addition, Legg Mason Wood Walker is a member of the Philadelphia,
Pacific and Chicago Stock Exchanges.
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Brokerage Offices
The following table reflects, as of March 31, 1997, certain
information with respect to the Company's securities brokerage offices.
Number of
Financial Number of
Location Advisors Offices
United States:
Maryland..................... 261 16
Pennsylvania................. 190 20
Virginia..................... 101 9
Louisiana.................... 80 9
North Carolina............... 64 8
Massachusetts................ 50 3
Texas........................ 44 4
District of Columbia......... 40 1
Florida...................... 37 9
Ohio......................... 35 3
New York..................... 27 3
Alabama...................... 18 3
Connecticut.................. 17 3
New Jersey................... 15 5
Mississippi.................. 15 3
Delaware..................... 13 2
Maine........................ 13 1
West Virginia................ 12 2
Tennessee.................... 9 1
South Carolina............... 7 1
Rhode Island................. 5 1
United Kingdom:
London....................... 4 1
France:
Paris........................ 3 1
TOTAL................. 1,060 109
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Revenues by Source
The following table sets forth certain information regarding the
revenues of the Company by source.
LEGG MASON, INC. AND SUBSIDIARIES
Years Ended March 31,
1995 1996 1997
(Dollars in thousands)
Amount Percent Amount Percent Amount Percent
Commissions
Listed & Over-the-
Counter............. $ 85,770 22.0% $116,187 22.5% $124,841 19.5%
Mutual Funds.......... 23,315 6.0 35,276 6.8 41,054 6.4
Insurance & Annuities. 11,621 3.0 14,409 2.8 20,436 3.2
Options & Commodities. 2,270 0.6 3,309 0.7 3,649 0.6
Total............... 122,976 31.6 169,181 32.8 189,980 29.7
Principal Transactions(1)
Customer Related:
Government & Agency. 12,986 3.3 12,406 2.4 14,660 2.3
Municipal........... 17,901 4.6 14,845 2.9 15,662 2.4
Corporate Debt...... 5,989 1.5 8,817 1.7 8,437 1.3
Over-the-Counter.... 18,467 4.8 24,112 4.7 31,327 4.9
55,343 14.2 60,180 11.7 70,086 10.9
Dealer Related:
Government & Agency. 903 0.2 1,171 0.2 1,602 0.3
Municipal........... (75) - (205) - 46 -
Corporate Debt...... 515 0.2 398 0.1 295 0.0
Over-the-Counter.... 2,784 0.7 4,326 0.8 1,152 0.2
4,127 1.1 5,690 1.1 3,095 0.5
Total.............. 59,470 15.3 65,870 12.8 73,181 11.4
Investment Advisory &
Related Fees.......... 102,518 26.4 144,790 28.0 183,401 28.7
Investment Banking(2)
Corporate............. 27,078 7.0 36,495 7.1 63,850 10.0
Municipal............. 7,575 1.9 6,833 1.3 8,212 1.3
Total.............. 34,653 8.9 43,328 8.4 72,062 11.3
Interest Income......... 39,697 10.2 57,098 11.1 84,076 13.1
Other(3)................ 29,751 7.6 35,776 6.9 37,006 5.8
Total Revenues..... $389,065 100.0% $516,043 100.0% $639,706 100.0%
(1) Principal transactions (securities transactions in which the Company
buys for or sells from its own inventory) are classified as "Customer
Related" when such transactions are effected with a customer of the
Company (whether an individual or institutional investor) and as
"Dealer Related" when such transactions are effected with another
dealer.
(2) Principally selling concessions from underwriting participations
and fees from managed and co-managed offerings.
(3) Includes revenues from mortgage servicing and loan originations
(1995: $14,603; 1996: $19,192; 1997: $16,922).
5
Retail Securities Business
For the fiscal years ended March 31, 1995, 1996 and 1997,
revenues derived from securities transactions for individual
investors (excluding interest on margin accounts) constituted
approximately 87%, 88% and 84%, respectively, of total revenues
from securities transactions and 44%, 42% and 39%, respectively,
of the Company's total revenues. Management believes that such
services will continue to be the Company's primary source of revenues
in the foreseeable future, although the percentage of total revenues
may decrease primarily as a result of increases in investment advisory
and investment banking revenues. Retail commissions are charged on both
exchange and over-the-counter ("OTC") transactions in accordance with
a schedule which the Company has formulated and may change from time to
time. Discounts from the schedule are granted in certain cases.
The Company also offers certain account arrangements under which a
single fee is charged based on a percentage of the assets held in a
customer's account and no commissions are charged on a transaction-
by-transaction basis. When OTC transactions are executed by the Company
as a dealer, the Company receives, in lieu of commissions, mark-ups or
mark-downs that are included in the "Revenues by Source" table as
customer-related principal transactions. The Company has dealer-sales
agreements with several major distributors that offer mutual fund shares
through broker-dealers. In addition, the Company sells shares of
Company-sponsored mutual funds. See "Company-Sponsored Mutual Funds."
Margin Accounts, Interest Income and Free Credit Balances
Customers' securities transactions are effected on either a cash
or a margin basis. In a margin account, the customer pays less than
the full cost of the securities purchased and the broker-dealer makes
a loan for the balance of the purchase price secured by the securities
purchased or other securities owned by the customer. The amount of the
loan is subject to the margin regulations (Regulation T) of the Board
of Governors of the Federal Reserve System, NYSE margin requirements,
and the Company's internal policies, which in some instances are more
stringent than Regulation T or NYSE requirements. In permitting a
customer to purchase securities on margin, the Company is subject to
the risk that a market decline could reduce the value of its collateral
below the amount of the customer's indebtedness and that the customer
might be unable otherwise to repay the indebtedness.
Interest is charged on amounts borrowed by customers (debit
balances) to finance their margin transactions. The rate of interest
charged to customers is the brokers' call money rate (the interest
rate on bank loans to brokers collateralized by securities) plus an
additional amount that varies depending upon the size of the customer's
debit balance and level of account activity. Interest income derived
from these sources constituted approximately 5% of the Company's total
revenues for each of the fiscal years ended March 31, 1995, 1996 and 1997.
Interest is also earned on securities owned by the Company and on operating
and segregated cash balances.
Free credit balances (excess funds kept by customers in their
brokerage accounts) and equity capital are the primary
6
sources of funds used to finance customers' margin account borrowings.
Legg Mason Wood Walker pays interest on certain free credit balances in
customers' accounts when the customer has indicated that the funds will
be used for reinvestment at a future date. In fiscal 1997, Legg Mason
Wood Walker paid interest on approximately 90% of customer free credit
balances.
Institutional Business
The Company is engaged in executing securities transactions for
institutional investors such as banks, mutual funds, insurance companies
and pension and profit-sharing plans. Such investors normally purchase
and sell securities in large quantities which require special marketing
and trading expertise. The Company believes that a significant portion
of its institutional brokerage commissions is received as a consequence
of provision to institutions of research opinions and services regarding
specific corporations and industries and other matters affecting the
securities markets. See "Research."
Transactions are executed by the Company acting as broker or as
principal. The Company permits discounts from its commission schedule
to its institutional customers. The size of such discounts varies with
the size of particular transactions and other factors. For the fiscal
years ended March 31, 1995, 1996 and 1997, revenues derived from
securities transactions for institutional investors constituted
approximately 13%, 12% and 16%, respectively, of total revenues from
securities transactions and 6%, 6% and 7%, respectively, of the Company's
total revenues.
Principal Transactions
The Company makes primary markets in equity securities that are
traded OTC, particularly securities of companies located in the Mid-Atlantic
and Mid-South regions. The Company is also an active market maker and
distributor of municipal bonds, particularly bonds issued by municipalities
located in the Mid-Atlantic and Mid-South regions.
As of March 31, 1997, the Company made markets in equity securities
of approximately 360 corporations, including corporations for which the
Company has acted as a managing or co-managing underwriter. The Company
has 33 traders involved in trading corporate equity and debt securities,
9 in trading municipal securities, and 13 in trading government securities.
The Company's market-making activities are also conducted with other
dealers, and with institutional and individual customers of its branch
office system. In making markets in equity and debt securities, the Company
maintains positions in such securities to service its customers and
accordingly exposes its own capital to the risk of fluctuations in market
value. While the Company seeks to avoid substantial market risk, and may
engage in hedging transactions to minimize risk, it does, nonetheless,
realize profits and losses from market fluctuations. Trading profits
or losses) depend upon the skills of the employees engaged in market making,
the amount of capital allocated to positions in securities and the general
level of activity and trend of prices in the securities markets.
7
Investment Banking
Corporate and Municipal Finance
The Company participates as an underwriter in public offerings of
corporate debt and equity issues as well as municipal securities.
The Company also serves as manager or co-manager of corporate equity and
municipal offerings, generally involving issuers located in the Mid-Atlantic
and Mid-South regions.
The following tables set forth, for the periods indicated, (i)
the total number and dollar amount of corporate stock and bond and
municipal bond offerings managed or co-managed by the Company, and (ii)
the total number and dollar amount of its underwriting participations in
those offerings and in offerings managed by others.
Managed or Co-Managed Offerings
Calendar Year Number of Issues Amount of Offering
Corporate Municipal Corporate Municipal
1992 62 314 $7,361,066,000 $10,091,755,000
1993 81 340 9,949,500,000 15,715,724,000
1994 24 227 3,764,956,000 5,779,156,000
1995 22 165 958,377,000 4,112,580,000
1996 33 258 3,808,000,000 5,555,638,000
Underwriting Participations
Calendar Year Number of Issues Amount of Participation
Corporate Municipal Corporate Municipal
1992 500 362 $1,139,104,000 $1,845,151,000
1993 598 458 1,396,410,000 6,017,729,000
1994 411 309 776,258,000 1,187,236,000
1995 354 232 675,257,000 627,973,000
1996 427 246 1,313,233,000 587,548,000
Underwriting involves both economic and regulatory risks. An
underwriter may incur losses if it is unable to resell the securities it
is committed to purchase, or if it is forced to liquidate its commitments
at less than the agreed purchase price. In addition, an underwriter is
subject to substantial potential liability for material misstatements or
omissions in prospectuses and other communications with respect to
underwritten offerings. See "Item 3. Legal Proceedings." Furthermore,
because underwriting commitments require a charge against net capital,
the Company's broker-dealer subsidiaries could find it necessary to limit
their underwriting participations to remain in compliance with regulatory
net capital requirements. See "Net Capital Requirements."
Other Investment Banking Activities
The Company's investment banking activities also include private debt
and equity placements and initiation and advice with respect to merger and
acquisition transactions, as well as
8
provision of financial advisory services to corporate and municipal clients.
The Company sells interests in both private and public limited
partnership investments and in the past has originated real estate
securities partnership offerings, although activities in this area
have not been significant for several years. In self-originated
offerings, subsidiaries of the Company serve as general partners of
limited partnerships sponsored by the Company, which may subject the
Company to the potential liabilities that can arise as a result of such
service.
At March 31, 1997, the Company had 76 professionals engaged in
investment banking activities, including 45 in corporate finance and 31
in municipal finance.
Company-Sponsored Mutual Funds
The Company, through various subsidiaries, sponsors and serves as
investment advisor and distributor for domestic and international equity,
fixed-income and money market mutual funds and offshore investment funds.
As of March 31, 1996 and 1997, the aggregate net assets of all of these
proprietary funds were approximately $7.1 billion and $9.1 billion,
respectively.
For the fiscal years ended March 31, 1995, 1996 and 1997, the
Company received approximately $21.0 million, $26.0 million and $37.8
million, respectively, in asset-based sales charges from its proprietary
mutual funds.
Investment Advisory Services
Legg Mason Fund Adviser, Inc. serves as investment adviser to or
manager of various Company-sponsored mutual funds.
Western Asset Management Company specializes in the management of
fixed-income assets for institutional clients. At March 31, 1996 and
1997, Western had approximately $17.8 billion and $24.6 billion,
respectively, under management (not including assets in Company-sponsored
mutual funds for which it serves as investment adviser).
Batterymarch Financial Management, Inc. manages emerging markets,
international, and U.S. equity portfolios for institutional clients.
At March 31, 1996 and 1997, Batterymarch managed assets with a value of
approximately $4.0 billion and $4.1 billion, respectively.
Bartlett & Co., acquired in January 1996, manages securities
portfolios for high net worth individuals, family groups and institutions.
At March 31, 1996 and 1997, Bartlett managed assets with a value of
approximately $2.2 billion and $2.4 billion, respectively.
Gray, Seifert & Co., Inc. manages securities portfolios for wealthy
individuals and family groups, endowments, and foundations. At
March 31, 1996 and 1997, Gray Seifert managed assets with a value of
approximately $840 million and $950 million, respectively.
9
Western Asset Global Management Limited, acquired in February 1996,
manages international fixed-income securities and currencies for
institutions worldwide. At March 31, 1996 and 1997, Western Asset Global
managed assets with a value of approximately $2.7 billion and $2.1 billion,
respectively.
The Company has revenue sharing agreements with Western, Batterymarch,
Gray Seifert and Bartlett and certain of their key officers pursuant to which
a specified percentage of the subsidiary's revenues is distributed to Legg
Mason, Inc., and the balance of the revenues is retained by the subsidiary
to pay its operating expenses, including salaries and bonuses, with specific
expense and compensation allocations being determined by the subsidiary's
management.
Legg Mason Capital Management, Inc. manages securities portfolios of
individual and institutional clients. At March 31, 1996 and 1997, this
subsidiary managed assets with values of approximately $820 million and
$980 million, respectively, including approximately $125 million and
$145 million, respectively, of the Company's funds invested in short-term
securities (not including assets in Company-sponsored mutual funds for
which it serves as investment adviser).
Fairfield Group, Inc., offers several investment vehicles
structured to meet the specialized investment needs of banks and bank
trust departments. These include the Navigator taxable and tax-free
money market funds, with combined assets of approximately $260 million
and $210 million at March 31, 1996 and 1997, respectively, and Navigator
REPO/LINE, a service which invested approximately $1.1 billion and
$1.4 billion at March 31, 1996 and 1997, respectively, of short-term
cash in repurchase agreements collateralized by U.S. government and
government agency securities.
The Company's advisory activities also include wrap-fee programs
in which the Company's customer pays a single asset-based fee that covers
all execution and advisory services, including advisory services provided
by the Company's investment advisory affiliates and selected independent
advisory firms. In addition, the Company provides asset allocation and
advisor performance and selection consultation services.
Mortgage Banking and Real Estate Services
Legg Mason Real Estate Services, Inc. ("LMRES") and Legg Mason
Dorman & Wilson, Inc. are engaged in the commercial mortgage banking
business. These firms originate, structure, place and service
commercial mortgages on income-producing properties for insurance
companies, pension funds and other investors. LMRES is also engaged
in the business of managing commercial mortgage portfolios on behalf
of pension funds, with a major portion of this business consisting of
management services provided to four public pension funds. In addition,
LMRES provides real estate consulting services, specializing in sports
arena and facility feasibility, analysis and financing, as well as in
providing corporate real estate services and equity sales. LMRES'
headquarters are located in Philadelphia, Pennsylvania, and it has
offices located in the Mid-Atlantic and Southeastern regions of the
United States. Legg
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Mason Dorman & Wilson is headquartered in White Plains, New York, and has
offices in New York, New Jersey and Massachusetts.
As of March 31, 1996 and 1997, the combined commercial mortgage
servicing portfolios of LMRES and Legg Mason Dorman & Wilson totaled
approximately $10.0 billion.
Insurance Brokerage and Financial Planning
Approximately 930 of the Company's financial advisors are licensed
to sell insurance. Legg Mason Financial Services, Inc., a wholly-owned
subsidiary of the Company, acts as general agent for several life
insurance companies and sells fixed and variable annuities and insurance.
The Company also offers comprehensive financial planning services to
individuals.
Other Services
At March 31, 1997, the Company served as a non-bank custodian for
approximately 122,000 IRA's, 13,500 Simplified Employee Pension Plans
and 3,000 Qualified Plans.
The Company effects the purchase and sale of options and commodities
contracts on behalf of clients.
In March 1993, the Company established the Legg Mason Trust Company,
a state chartered, non-depository bank, to provide services as a trustee
for trusts established by the Company's individual and employee benefit
plan clients. The Company provides brokerage and advisory services for
a significant portion of the assets held in the Trust Company's accounts.
Research
The Company employs 36 analysts who develop investment recommendations
and market information with respect to companies and industries. Legg Mason
Wood Walker's research emphasizes the identification of securities of
financially sound, well-managed companies that appear to be undervalued in
relation to their long-term earning power or the value of underlying assets.
Legg Mason refers to this investment strategy as the "Value Approach" to
investing. Howard Weil's analysts concentrate on the oil and gas
exploration, pipeline and service industries. The Company's research
services are supplemented by research services purchased from outside
consultants.
The Company's clients do not pay for research services directly,
although the Company is often compensated for its research services by
institutional clients through the direction of brokerage transactions
to the Company for execution. The Company believes that its research
activities are extremely important in attracting and retaining individual
and institutional brokerage and investment advisory clients.
Operations
Administrative and operations personnel are responsible for the
processing of securities transactions; receipt, identification and
delivery of funds and securities; internal
11
financial controls; office services; custody of customers' securities and
the handling of margin accounts. At March 31, 1997, the Company had
approximately 300 full-time employees performing such functions.
There is considerable fluctuation during any year and from year to
year in the volume of transactions the Company must process. During the
fiscal years ended March 31, 1995, 1996 and 1997, the Company processed
approximately 2,056,000, 2,586,000 and 3,097,000 securities transactions,
respectively. The Company records transactions and posts its books on a
daily basis. Operations personnel monitor day-to-day operations to
determine compliance with applicable laws, rules and regulations. Failure
to keep current and accurate books and records can render the Company liable
to disciplinary action by governmental and self-regulatory authorities.
Legg Mason Wood Walker executes and clears all of its own securities
transactions as a member of the NYSE and various regional exchanges, clearing
corporations and depositories.
The Company believes that its internal controls and safeguards are
adequate, although fraud and misconduct by customers and employees and the
possibility of theft of securities are risks inherent in the securities
industry. As required by the NYSE and certain other authorities, the
Company carries a fidelity bond covering loss or theft of securities as
well as forgery of checks and drafts and embezzlement and misplacement of
securities. The bond provides total coverage of $30,000,000 (subject to
a $1,000,000 deductible per claim).
Employees
At March 31, 1997, the Company had approximately 3,460 employees.
None of the Company's employees is covered by a collective bargaining
agreement. The Company considers its relations with its employees to
be satisfactory. However, competition for experienced financial services
personnel, especially financial advisors and investment management
professionals, is keen and from time to time the Company may experience
a loss of valuable personnel.
The Company recognizes the importance of hiring and training financial
advisors. The Company trains new financial advisors who are required to
take examinations given by the NYSE, the NASD and various states in order
to be registered and qualified, and maintains ongoing training for financial
advisors.
Competition
The Company is engaged in an extremely competitive business. Its
competition includes, with respect to one or more aspects of its business,
numerous national, regional and local broker-dealer and investment advisory
firms, and commercial banks and thrift institutions. Many of these
organizations have substantially greater personnel and financial resources
than the Company. Discount brokerage firms oriented to the retail market,
including firms affiliated with banks and mutual fund organizations, are
devoting substantial funds to advertising and
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direct solicitation of customers in order to increase their share of
commission dollars and other securities-related income. In many
instances, the Company is competing directly with such organizations.
The Company also competes for investment funds with banks, insurance
companies and investment companies. The principal competitive factors
relating to the Company's business are the quality of advice and services
provided to investors and the price of those services.
Competition in the Company's business periodically has been affected
by significant developments in the securities industry. See "Factors
Affecting the Company and the Securities Industry -- Industry Changes and
Competitive Factors."
Regulation
The securities industry in the United States is subject to extensive
regulation under both Federal and state laws. The SEC is the Federal agency
charged with administration of the Federal securities laws. Much of the
regulation of broker-dealers has been delegated to self-regulatory
authorities, principally the NASD and the securities exchanges. These
self-regulatory organizations conduct periodic examinations of member
broker-dealers in accordance with rules they have adopted and amended from
time to time, subject to approval by the SEC. Securities firms are also
subject to regulation by state securities commissions in those states in
which they do business. In addition, securities firms are subject to
regulation by various foreign governments, securities exchanges, central
banks and regulatory bodies, particularly in those countries where they
have established an office.
Broker-dealers are subject to regulations that cover all aspects of
the securities business, including sales methods, trading practices among
broker-dealers, uses and safekeeping of customers' funds and securities,
capital structure and financial soundness of securities firms, recordkeeping
and the conduct of directors, officers and employees. Additional legislation,
changes in rules promulgated by the SEC and self-regulatory authorities, or
changes in the interpretation or enforcement of existing laws and rules, may
directly affect the mode of operation and profitability of broker-dealers.
The SEC, self-regulatory authorities and state securities commissions may
conduct administrative proceedings that can result in censure, fine,
suspension or expulsion of a broker-dealer, its officers or employees.
Such administrative proceedings, whether or not resulting in adverse
findings, can require substantial expenditures and can have an adverse
impact on the reputation of a broker-dealer. The principal purpose of
regulation and discipline of broker-dealers is the protection of customers
and the securities markets, rather than protection of creditors and
stockholders of the regulated entity.
The Company's investment advisory subsidiaries and the Company-sponsored
mutual funds are also subject to extensive federal and state regulation by
the SEC and state securities commissions.
The Company's broker-dealer subsidiaries are required by federal law
to belong to the SIPC. When the SIPC fund falls below a
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certain amount, members are required to pay annual assessments of up to 1%
of adjusted gross revenues. As a result of adequate fund levels, the
Company's broker-dealer subsidiaries each were required to pay
the minimum annual assessment of $150 in fiscal 1997. The SIPC fund provides
protection for securities held in customer accounts up to $500,000 per
customer, with a limitation of $100,000 on claims for cash balances. The
Company purchases insurance that provides additional protection for
securities of up to $24,500,000 per customer.
Net Capital Requirements
Every registered broker-dealer doing business with the public is subject
to the Uniform Net Capital Rule (Rule 15c3-1) promulgated by the SEC. The
Rule, which is designed to measure the financial soundness and liquidity of
broker-dealers, specifies minimum net capital requirements. Since the Company
is not itself a registered broker-dealer, it is not directly subject to the
Uniform Net Capital Rule. However, its broker-dealer subsidiaries are subject
to the Rule, and a provision of the Rule requires that a broker-dealer notify
the SEC prior to the withdrawal of equity capital by a parent company if the
withdrawal would exceed the greater of $500,000 or 30 percent of the broker-
dealer's excess net capital.
Rule 15c3-1 provides that a broker-dealer doing business with the public
shall not permit its aggregate indebtedness to exceed 15 times its net capital
(the "primary method") or, alternatively, that it not permit its net capital
to be less than 2% of its aggregate debit items (primarily receivables from
customers and broker-dealers) computed in accordance with such Rule. As of
March 31, 1997, the Company's broker-dealer subsidiaries had aggregate net
capital of $132.7 million, which exceeded the minimum net capital requirements
by $120.8 million.
Under NYSE Rule 326, Legg Mason Wood Walker as a member organization that
carries customer accounts, would be required to reduce its business activities
if its net capital, as defined, was less than 4% of aggregate debit items, as
defined, and would be precluded from expanding its business if its net capital
was less than 5% of aggregate debit items.
Compliance with applicable net capital rules could limit operations of
the Company's broker-dealer subsidiaries, particularly operations such as
underwriting and trading activities that require use of significant amounts
of capital. A significant operating loss or an extraordinary charge against
net capital could adversely affect the ability of the broker-dealers to
expand or even maintain their present levels of business. See Note 15 of
Notes to Consolidated Financial Statements in Item 8 of this Report.
Outstanding Subordinated Liabilities
Legg Mason Wood Walker has incurred subordinated liabilities
("Subordinated Liabilities") which it is permitted to treat as capital for
the purposes of the Uniform Net Capital Rule and NYSE Rules 325 and 326.
The Subordinated Liabilities instruments issued by Legg Mason Wood Walker
provide that such
14
liabilities shall be subordinated in right of payment to the prior payment
in full, or provision for such payment, of all obligations to all other
present and future creditors of Legg Mason Wood Walker (except
for other Subordinated Liabilities similarly subordinated). At March 31,
1997, Legg Mason Wood Walker had a $5.0 million Subordinated Liability
outstanding, due to Legg Mason, Inc. The Subordinated Liability may, with
the prior written consent of the NYSE, be prepaid in whole or in part at any
time after such Subordinated Liability has been outstanding for more than
one year. Legg Mason Wood Walker may not pay or permit the payment or
withdrawal of any Subordinated Liability if, after giving effect to such
payment or withdrawal, its net capital would be less than 5% (6% in the
case of the Subordinated Liability due to Legg Mason, Inc.) of aggregate
debit items. See Note 15 of Notes to Consolidated Financial Statements in
Item 8 of this Report.
Factors Affecting the Company and the Securities Industry
The securities industry is characterized by frequent change, the effects
of which have been difficult to predict. In addition to an evolving
regulatory environment, the industry has been subject to radical changes in
pricing structure, alternating periods of contraction and expansion and
intense competition from within and outside the industry.
Fluctuating Securities Volume and Prices
The securities industry is subject to substantial fluctuations in volume
and price levels of securities transactions. These fluctuations can occur
on a daily basis as well as over longer periods as a result of national and
international economic and political events, and broad trends in business
and finance. Reduced volume and prices generally result in lower brokerage
and investment banking revenues, as well as losses from trading as principal
and from underwriting. Profitability is adversely affected in periods of
reduced volume because fixed costs remain relatively unchanged. To the
extent that purchases of securities are permitted to be made on margin,
securities firms also are subject to risks inherent in extending credit,
especially during periods of rapidly declining markets, in that a market
decline could reduce collateral value below the amount of a customer's
indebtedness. In the past, heavy trading volume has caused clearance and
processing problems for many securities firms, and this could occur in the
future. In addition, there is risk of loss from errors that can occur in
the execution and settlement process. See "Operations."
Industry Changes and Competitive Factors
Considerable consolidation has occurred in the securities industry as
numerous securities firms have either ceased operations or been acquired by
other securities firms, in many cases resulting in firms with greater
financial resources than firms such as the Company. In addition, a number of
substantial companies not previously engaged in the securities business have
made investments in and acquired securities firms. Increasing competitive
pressures in the securities industry require regional securities firms to
offer to their customers many of the financial services that are provided by
much larger securities firms that have substantially
15
greater resources than the Company. A sizeable number of new investment
advisory firms and mutual funds have been established in recent years,
increasing competition in that area of the Company's activities.
An increasing number of firms, including affiliates of banks and mutual
fund organizations, that offer discount brokerage services to retail customers
have been established in recent years. These firms generally effect
transactions at lower commission rates on an "execution only" basis, without
offering other services such as investment advice and research that are
provided by "full-service" brokerage firms such as the Company. In addition,
some discount brokerage firms have increased the range of services that they
offer. Continued increases in the number of discount brokerage firms and
services provided by such firms may adversely affect the Company.
Certain institutions, notably commercial banks and thrift institutions,
have become a competitive factor in the securities industry by offering
certain investment banking and corporate and individual financial services
traditionally provided only by securities firms. The Federal Reserve Board
has approved applications of major commercial banks to underwrite and deal in
certain types of securities that such banks had not been permitted to
underwrite and deal in previously, subject to limitations on the resulting
underwriting volume and market share. Commercial banks, generally, are
expanding their securities activities, as well as their activities relating
to the provision of financial services, and are deriving more revenue from
such activities. Continued expansion of the type and extent of competitive
services that banks and other institutions offer or further repeal or
modification of administrative or legislative barriers may adversely affect
securities firms such as the Company that are heavily oriented to individual
retail customers.
Regulation
The business of the Company and its subsidiaries in the securities
industry is subject to regulation by various regulatory authorities that are
charged with protecting the interests of broker-dealers' customers. See
"Regulation."
Effect of Net Capital Requirements
The SEC and the NYSE have stringent rules with respect to the net capital
requirements of securities firms. A significant operating loss or
extraordinary charge against net capital may adversely affect the ability
of the Company's broker-dealer subsidiaries to expand or even maintain their
present levels of business. See "Net Capital Requirements."
Litigation
Many aspects of the Company's business involve substantial risks of
liability. In the normal course of business, the Company's subsidiaries have
been named as defendants or co-defendants in lawsuits seeking substantial
damages. There has been an increased incidence of litigation in the securities
industry in recent years, including customer claims as well as
16
class action suits seeking substantial damages. See "Item 3. Legal
Proceedings."
Item 2. Properties.
The Company currently leases all of its office space. The Company's
headquarters are located in an office building in which the Company is the
major tenant. The Company currently occupies approximately 93,000 square
feet in that building for a term expiring in February 1998. An additional
107,000 square feet in a different location is occupied by the Company's
administrative and operations functions.
In October 1997 the Company entered into a lease for approximately
270,000 square feet in a building in which the Company will be the major
tenant and in which its headquarters, administrative and operations
functions will be consolidated. The initial term of the lease will expire
in 2009 and annual base rent will be approximately $5.8 million. The lease
has two renewal options of eight years each.
Information concerning location of the Company's sales offices is
contained in Item 1 of this Report. See Note 9 of Notes to Consolidated
Financial Statements in Item 8 of this Report.
Item 3. Legal Proceedings.
Nasdaq Market-Makers Antitrust Litigation
Legg Mason Wood Walker and approximately thirty other broker-dealer firms
have been named as defendants in a number of purported class actions filed in
various federal courts alleging violation of federal antitrust laws. The
first of these actions was filed in May 1994, and in October 1994 the actions
were consolidated in the United States District Court for the Southern
District of New York under the caption In re Nasdaq Market-Makers Antitrust
Litigation. The consolidated complaint alleges that the defendants violated
the antitrust laws by conspiring to raise, fix and maintain the "spreads" on
certain securities traded on Nasdaq by refusing to quote bids and asks in
so-called "odd-eighths." The actions purport to be brought on behalf of all
persons who purchased or sold these securities on Nasdaq during the
approximately five-year period preceding commencement of the litigation. The
plaintiffs seek treble damages in an unspecified amount, injunctive relief,
and attorneys' fees and costs. The Court has certified a class, and discovery
proceedings have commenced.
Following the commencement of the antitrust litigation, the Securities
and Exchange Commission commenced an investigation relating to the allegations
in the litigation. Legg Mason Wood Walker, together with other broker-dealer
firms, has received requests for information from the Commission.
In addition to the matter described above, the Company's subsidiaries
have been named as defendants or co-defendants in various other lawsuits
alleging substantial damages. Some of these proceedings relate to public
offerings of securities in which one or more subsidiaries of the Company
participated as a member of the
17
underwriting syndicate. The Company is also aware of litigation against
certain underwriters of offerings in which one or more subsidiaries of the
Company was a participant, but where the subsidiary is not now a defendant.
In these latter cases, it is possible that a subsidiary may be called upon
to contribute to settlements or judgments. While the ultimate resolution of
pending litigation cannot be predicted with certainty, in the opinion of
management, after consultation with legal counsel, pending litigation will
not have a material adverse effect on the consolidated financial statements
of the Company.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
Item 4A. Executive Officers of the Company.
Information (not included in the Company's definitive proxy
statement for the 1997 Annual Meeting of Stockholders) regarding certain
executive officers of the Company is as follows:
F. Barry Bilson, age 44, was elected Vice President-Finance
of the Company in June 1984. He served as Controller of the Company from
October 1983 until September 1988, and as Controller of Legg Mason Wood
Walker from April 1981 to September 1988. From December 1978 to March 1981,
he was Assistant Controller of the Coatings Division of Dutch Boy, Inc. Mr.
Bilson is a certified public accountant.
Robert A. Frank, age 47, became Executive Vice President of the
Company and Executive Vice President, Director of Research and Co-head of the
Capital Markets Committee of Legg Mason Wood Walker in August 1996. From 1975
until he joined the Company, he was employed by Alex. Brown Incorporated in
various capacities, including as a Managing Director and Head of the Real
Estate Securities Research Group. Mr. Frank is a former Governor of the
National Association of Real Estate Investment Trusts, past president of the
Real Estate Analyst Group of New York, a Fellow of the Financial Analysts
Federation and a trustee of the Mid-Atlantic Realty Trust.
Theodore S. Kaplan, age 54, became Senior Vice President and
General Counsel of the Company in April 1993. From 1970 until he joined the
Company, he was engaged in the private practice of law with the firm of
Weinberg and Green. Prior to 1970, Mr. Kaplan served as an attorney in the
Office of the General Counsel and Division of Corporation Finance of the
Securities and Exchange Commission.
Timothy C. Scheve, age 39, has been Treasurer of the Company
and of Legg Mason Wood Walker since January 1992. He became a Vice President
of the Company in August 1993 and a Senior Vice President of Legg Mason Wood
Walker in August 1994. Mr. Scheve has served in various financial and
administrative capacities since joining the Company in 1984. Mr. Scheve was
a management consultant with Price Waterhouse & Co. prior to joining the
Company.
Elisabeth N. Spector, age 49, became a Senior Vice President of
the Company and Legg Mason Wood Walker in January 1994. She has general
responsibilities in business and financial strategy.
18
From November 1989 until she joined the Company, Ms. Spector was employed by
the Resolution Trust Corporation, where, among other things, she served as
the initial Director of the RTC's Capital Markets Division. From 1975 to
November 1989 she was an investment banker with Merrill Lynch & Co., Inc.
Edward A. Taber III, age 53, became an Executive Vice President
of the Company in September 1992 and a Senior Executive Vice President in
July 1995. He is responsible for supervising the Company's investment
management activities. From 1973 until he joined the Company, Mr. Taber held
various positions with T. Rowe Price Associates, Inc., an investment
management firm, last serving as Director of that firm's taxable fixed income
division. Prior to 1973, Mr. Taber served as the Treasurer and Chief
Financial Officer of the Federal Home Loan Bank of Boston. Mr. Taber is a
Director of the Legg Mason Value Trust, Inc., the Legg Mason Total Return
Trust, Inc., the Legg Mason Special Investment Trust, Inc., a trustee of the
Legg Mason Tax-Free Income Fund and the Legg Mason Cash Reserve Trust,
President and a director of the Legg Mason Income Trust, Inc., the Legg Mason
Global Trust, Inc., and the Legg Mason Investors Trust, Inc., and Vice
President of the Worldwide Value Fund, Inc.
19
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters.
Shares of Legg Mason, Inc. common stock are listed and traded
on the New York Stock Exchange (symbol LM). As of March 31, 1997,
there were 1,598 shareholders of record of the Company's common stock.
Information with respect to the Company's dividends and stock prices
is as follows:
Quarter ended
Mar. 31 Dec. 31 Sept. 30 June 30
1997
Cash dividend per share $ .13 $ .13 $ .13 $ .12
Stock price range:
High 51.375 39.375 34.000 33.625
Low 37.750 31.750 28.000 27.500
1996
Cash dividend per share $ .12 $ .12 $ .12 $ .11
Stock price range:
High 31.125 31.375 30.625 28.625
Low 26.500 27.375 26.500 23.125
20
Item 6. Selected Financial Data *
(Dollars in thousands except per share amounts)
Years ended March 31,
1997 1996 1995 1994 1993
OPERATING RESULTS
Revenues $ 639,706 $ 516,043 $389,065 $415,936 $353,523
Expenses 544,504 452,189 361,362 356,313 304,487
Earnings before income taxes 95,202 63,854 27,703 59,623 49,036
Income taxes 38,609 25,987 11,436 23,326 18,800
Net earnings $ 56,593 $ 37,867 $ 16,267 $ 36,297 $ 30,236
PER COMMON SHARE
Primary earnings $ 3.13 $ 2.48 $ 1.17 $ 2.70 $ 2.34
Fully diluted earnings $ 2.97 $ 2.15 $ 1.05 $ 2.24 $ 2.15
Dividends declared $ .51 $ .47 $ .43 $ .38 $ .312
Book value $ 22.91 $ 19.43 $ 16.98 $ 16.52 $ 14.36
Average shares outstanding:
Primary 18,058,511 15,273,113 13,853,330 13,433,911 12,898,109
Fully diluted 19,132,714 18,533,089 18,177,937 17,462,191 14,600,341
FINANCIAL CONDITION
Total assets $1,878,968 $1,314,500 $825,082 $819,984 $649,373
Senior notes $ 99,581 $ 99,534 ---- ---- ----
Subordinated liabilities ---- $ 68,000 $102,487 $102,487 $ 34,597
Total stockholders' equity $ 418,629 $ 298,906 $230,457 $215,676 $180,510
* Restated due to pooling of interests transaction.
21
Item 7. Management's Discussion and Analysis of Results of
Operations and Financial Condition
Legg Mason, Inc. and its subsidiaries (the "Company")
are principally engaged in providing securities brokerage, investment
advisory, investment banking and commercial mortgage banking services
to individuals, institutions, corporations and municipalities.
The Company's profitability is sensitive to a variety of factors
including the volume of trading in securities, the volatility and
general level of market prices, and the demand for investment banking
and mortgage banking services.
The favorable conditions in the U.S. securities markets
that prevailed in fiscal 1996 continued in fiscal 1997. In fiscal
1997, U.S. equity markets achieved record trading volume and price
levels, principally because of continuing economic growth, gains
in corporate earnings and modest inflation. As a result, each of
the Company's core businesses - securities brokerage, investment
advisory services and investment banking - contributed to a second
consecutive year of record earnings. It is uncertain if the favorable
conditions experienced in the past two fiscal years will continue
in fiscal 1998, or longer.
The Company's investment advisory activities and their
contribution to operating results have grown significantly, through
both internal growth and acquisition, over the past ten years. During
fiscal 1996, the Company acquired Bartlett & Co. ("Bartlett") and
Lehman Brothers Global Asset Management Limited, since renamed Western
Asset Global Management Limited ("Western Asset Global"), as described
in Note 2 of Notes to Consolidated Financial Statements. Bartlett,
acquired in January 1996, manages approximately $2.4 billion for high
net worth individuals, family groups and institutions. Western Asset
Global, acquired in February 1996, manages assets of approximately
$2.1 billion, invested principally in international fixed-income
securities and currencies. Total assets under management for
institutions, Company-sponsored mutual funds and private accounts
managed by the Company's subsidiaries were $43.8 billion at
March 31, 1997, up 24% from $35.4 billion a year earlier and from
$5.2 billion ten years ago. Earnings from investment advisory
services tend to be more stable than those from securities brokerage
and investment banking activities because they are less affected by
changes in securities market conditions.
The Company's financial statements for all periods
presented have been restated to include the results of Bartlett,
acquired on a pooling of interests basis in January 1996.
Results of any individual period should not be considered
representative of future profitability. Many of the Company's activities
have fixed operating costs which do not decline with reduced levels of
volume. While the Company attempts to reduce costs, particularly during
periods of low volume, it does not, as a general rule, attempt to do so
through personnel
22
reductions. Accordingly, sustained periods of unfavorable market conditions
may adversely affect profitability.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated,
items in the Consolidated Statements of Earnings as percentages of total
revenues and the increase (decrease) by item as a percentage of the
amount for the previous period:
Percentage of Total Revenues Period to Period Change
1997 1996
Years Ended March 31, Compared Compared
1997 1996 1995 to 1996 to 1995
REVENUES
Commissions 29.7% 32.8% 31.6% 12.3% 37.6%
Principal transactions 11.4 12.8 15.3 11.1 10.8
Investment advisory and
related fees 28.7 28.0 26.4 26.7 41.2
Investment banking 11.3 8.4 8.9 66.3 25.0
Interest 13.1 11.1 10.2 47.2 43.8
Other 5.8 6.9 7.6 3.4 20.3
100.0 100.0 100.0 24.0 32.6
EXPENSES
Compensation and benefits 56.7 58.0 59.3 21.1 30.0
Occupancy and equipment rental 6.7 7.1 7.9 18.2 18.0
Communications 4.8 5.4 6.8 8.7 5.9
Floor brokerage and clearing fees .9 1.0 1.4 16.8 (7.4)
Interest 6.8 5.1 4.4 65.6 51.9
Other 9.2 11.0 13.1 3.3 12.0
85.1 87.6 92.9 20.4 25.1
EARNINGS BEFORE INCOME TAXES 14.9 12.4 7.1 49.1 130.5
Income taxes 6.1 5.1 2.9 48.6 127.2
NET EARNINGS 8.8% 7.3% 4.2% 49.5% 132.8%
In fiscal 1997, revenues, net earnings and earnings per share
reached record levels and were substantially higher than in the prior fiscal
year. Revenues were $639.7 million, a 24% increase from revenues of $516.0
million in fiscal 1996. Net earnings were $56.6 million, up 49% from net
earnings of $37.9 million in the prior fiscal year. Primary earnings per
share increased 26% to $3.13 from $2.48. Fully diluted earnings per share
were $2.97, a 38% increase from $2.15 in fiscal 1996.
23
Revenues
Commissions
Commission revenues rose 12% to $190.0 million in fiscal
1997 because of increases in sales of listed securities, variable annuities
and non-affiliated mutual funds.
In fiscal 1996, commission revenues rose 38% to $169.2 million
from levels in fiscal 1995 because of increases in sales of listed securities,
non-affiliated mutual funds and over-the-counter securities.
During both fiscal 1997 and 1996, commission revenues benefited
from an active and rising stock market.
Principal Transactions
Revenues from principal transactions increased 11% to $73.2
million, primarily because of higher sales of over-the-counter stocks and
fixed-income securities, partially offset by losses on proprietary positions
in energy-related equity securities. Sales of over-the-counter securities
benefited from the favorable equity securities markets.
In fiscal 1996, revenues from principal transactions increased
11% to $65.9 million, principally as a result of increased sales of over-the-
counter stocks and corporate debt securities and higher trading profits on
firm proprietary positions, partially offset by a decline in sales of
municipal securities. Sales of corporate debt securities reflect a full
year's results from the Company's expansion of its taxable fixed-income
marketing capability during the prior fiscal year.
Investment Advisory and Related Fees
Investment advisory and related fees increased 27% to $183.4
million, principally as a result of growth in assets under management in
Company-sponsored mutual funds, the Company's fixed-income investment
advisory subsidiary and fee-based brokerage accounts. In addition, fiscal
1997 includes a full year of fees earned by Western Asset Global.
In fiscal 1996, investment advisory and related fees rose
41% to $144.8 million, as a result of fees earned by Batterymarch, coupled
with growth in assets under management in Company-sponsored mutual funds
and in the Company's fixed-income investment advisory subsidiary. Excluding
fees earned by Batterymarch, investment advisory and related fees rose 26%
in fiscal 1996.
24
Investment Advisory Revenues and
Assets Under Management
The graph here depicts the growth in Assets Under Management and
Investment Advisory and Related Fees Revenue for the five Fiscal
periods ended March 31, 1997.
1993 1994 1995 1996 1997
Assets Under Management
(in Millions) $13,069 $16,653 $24,561 $35,355 $43,771
Investment Advisory
and Related Fees
(in thousands) $64,361 $79,958 $102,518 $144,790 $183,401
Investment Banking
Investment banking revenues rose 66% to $72.1 million,
principally as a result of increased corporate finance activities,
particularly co-managed public offerings of energy and real estate
investment trust-related securities and financial advisory services.
In fiscal 1996, investment banking revenues rose 25%
to $43.3 million, principally as a result of increased fees from
private placement and financial advisory engagements. Gains in fees
from corporate stock offerings were substantially offset by a decline
in the number and size of co-managed offerings of real estate investment
trusts.
Other Revenues
Other revenues rose 3% to $37.0 million, principally as a
result of higher transaction-related fees, partially offset by a decline
in loan origination fees at the Company's commercial mortgage banking
subsidiaries.
In fiscal 1996, other revenues rose 20% to $35.8 million,
principally as a result of increased loan origination fees at the Company's
commercial mortgage banking subsidiaries.
25
Expenses
Compensation and Benefits
Compensation and benefits increased 21% to $362.9 million,
reflecting higher sales and profitability-based compensation and personnel
additions in sales, product and support areas.
In fiscal 1996, compensation and benefits increased 30% to
$299.6 million, reflecting higher sales and profitability-based compensation
and personnel additions as a result of increased business activity.
Additionally, fiscal 1996 includes the expenses of Batterymarch.
A substantial part of compensation expense fluctuates in
proportion to the level of business activity. Other compensation costs,
primarily salaries and benefits, are fixed and may not decline with reduced
levels of volume. Therefore, profitability may be adversely affected by
sustained periods of unfavorable market conditions or slow revenue growth
in acquired businesses or new product areas.
Occupancy and Equipment Rental
Occupancy and equipment rental increased 18% to $43.0 million
because of higher depreciation expense related to increased investments in
technology, higher transaction volume processed by the Company's data
processing service bureau and the addition of expenses of Western Asset
Global.
In fiscal 1996, occupancy and equipment rental increased
18% to $36.4 million because of increased rent and depreciation expense
related to new branch office locations and expanded product areas, higher
transaction volume processed by the Company's data processing service
bureau and the addition of expenses of Batterymarch.
Communications
Communications costs increased 9% to $30.5 million, primarily
because of higher printing and office supply expense as a result of increased
business activity and the addition of expenses of Western Asset Global.
In fiscal 1996, communications costs increased 6% to $28.1
million, principally because of increased quote service costs and the
addition of expenses of Batterymarch.
26
Floor Brokerage and Clearing Fees
Floor brokerage and clearing fees increased 17% to $5.9
million, reflecting an increase in securities transaction volume.
In fiscal 1996, despite increased trading volume, floor
brokerage and clearing fees fell 7% to $5.1 million, reflecting lower
execution expenses from more efficient order routing and execution
capabilities implemented during fiscal 1996.
Other Expense
Other expense increased 3% to $58.8 million, attributable
to increased promotional and consulting expenses and the addition of
expenses of Western Asset Global, offset in part by lower litigation-
related expenses.
In fiscal 1996, other expense increased 12% to $56.9 million,
attributable to the addition of Batterymarch, including amortization of
related intangible assets, which reduces net earnings but not operating
cash flows. In addition, fiscal 1996 includes expenses related to the
acquisition of Bartlett, offset by lower litigation-related expenses.
Interest Revenue and Expense
Interest revenue increased 47% to $84.1 million because of
larger firm investments, predominantly funds segregated for regulatory
cash purposes, and customer margin account and conduit stock loan balances.
Interest expense increased 66% to $43.4 million because of larger interest-
bearing customer credit and conduit stock loan balances. Additionally,
increased debt service related to $100 million of 6.50% Senior Notes
issued in February 1996 was partially offset by elimination of debt service
on the Company's 5.25% Convertible Subordinated Debentures, which were
converted into common stock in August 1996.
In fiscal 1996, interest revenue increased 44% to $57.1
million because of higher interest earned on customer margin accounts,
conduit stock loan balances and firm investments, reflecting larger
account balance levels and higher average interest rates. Interest
expense increased 52% to $26.2 million because of higher interest
payments on larger customer credit and conduit stock loan balances
and higher average interest rates.
As a result of substantially higher levels of interest
bearing customer credit balances, the Company's net interest margin
fell to 48.4% in fiscal 1997 from 54.2% in fiscal 1996.
27
Interest Revenue and Expense
(millions of dollars)
The graph here depicts Interest Revenue and Interest Expense for the
five fiscal periods ended March 31, 1997.
1993 1994 1995 1996 1997
Interest Revenue
(in thousands) $24,321 $30,332 $39,697 $57,098 $84,076
Interest Expense
(in thousands) $11,990 $15,468 $17,237 $26,177 $43,357
Income Taxes
Income taxes rose 49% to $38.6 million in fiscal 1997
and 127% to $26.0 million in fiscal 1996, principally because of
increases in pre-tax earnings. The Company's effective tax rate was
40.6%, 40.7% and 41.3% in fiscal 1997, 1996 and 1995, respectively.
The declines in fiscal 1997 and 1996 are attributable to lower
effective state income tax rates.
LIQUIDITY AND CAPITAL RESOURCES
The Company's assets are primarily liquid, consisting
mainly of cash and assets readily convertible into cash. These assets
are financed primarily by free credit balances, equity capital, senior
notes payable, bank lines of credit and other payables.
During the year ended March 31, 1997, cash and cash equivalents
increased $61.6 million. Cash flows from operating activities of $80.0
million were attributable to fiscal 1997 net earnings, adjusted for
depreciation and amortization. The Company invested cash of $21.6 million,
primarily in purchases of equipment. Cash flows from financing activities
provided $3.1 million, primarily from higher levels of short-term
borrowings and common stock issuance, offset by increased dividends
on common stock.
In July 1996, the Company called for redemption the $68.0
million aggregate principal amount outstanding of its 5.25%
28
Convertible Subordinated Debentures due May 1, 2003 (the "Debentures").
Substantially all holders converted their Debentures into common stock.
In February 1996, the Company issued $100 million of 6.50%
Senior Notes due February 15, 2006. The proceeds of the offering are being
used for general corporate purposes. The Company has available for
offering an additional $50 million of debt or convertible debt securities
pursuant to a shelf registration filed in January 1996.
In July 1995, the Company called for redemption the $34.5
million aggregate principal amount outstanding of its 7% Convertible
Subordinated Debentures due June 15, 2011. Substantially all holders
converted their 7% debentures into common stock.
In January 1995, the Company acquired the assets of Batterymarch
Financial Management utilizing $54.1 million in cash. An additional payment,
due in early 1998 and based on Batterymarch's achievement of specified
revenue levels for calendar 1997, could increase the total consideration
to a maximum of $120.0 million. Based on current revenues, it is anticipated
that no additional payment will be required.
The Company's broker-dealer subsidiaries are subject to the
requirements of the SEC's net capital rule which is designed to measure
the general financial soundness and liquidity of broker-dealers. At March 31,
1997, the brokerage subsidiaries had aggregate net capital of $132.7 million,
which exceeded minimum net capital requirements by $120.8 million.
Regulatory Net Capital
The graph here depicts Regulatory Net Capital Requirements
Required Net Capital at 3/31/97 $11,974
Excess Net Capital at 3/31/97 $120,762
Total Net Capital at 3/31/97 $132,736
The principal sources of the Company's funds are its investment
advisory and broker-dealer subsidiaries. The amount of the broker-dealers'
net assets that may be distributed is subject to restrictions under
applicable net capital rules. The Company
29
has a revolving bank line of credit in the amount of $50 million, none of
which is currently outstanding, and the Company's subsidiaries have lines of
credit, aggregating $292.5 million, pursuant to which they may borrow on a
short-term demand basis generally at prevailing broker call rates. Management
believes that funds available from operations and its lines of credit are
sufficient to meet its present and reasonably foreseeable capital needs,
although the Company may augment its capital funds for continued expansion by
internal growth and acquisition.
The Company borrows and lends securities in the normal course
of business to facilitate the settlement of its customer and proprietary
transactions. In addition, the Company engages in conduit securities
borrowing and lending activities in which it acts as an agent to facilitate
settlement for other institutions. In both firm and conduit transactions,
the Company deposits or receives cash, generally equal to 102% of the market
value of securities exchanged, and monitors the adequacy of collateral levels
on a daily basis.
EFFECTS OF INFLATION
The Company's assets are not significantly affected by inflation
because they are primarily monetary, consisting of cash, resale agreements,
securities and receivables. However, the rate of inflation affects various
expenses, including employee compensation, occupancy, and communications,
which may not be readily recoverable in charges for services provided by the
Company.
RECENT ACCOUNTING DEVELOPMENTS
In June 1996, the Financial Accounting Standards Board issued
Statement No. 125, "Accounting for Transfers and Servicing of Financial
Assets and Extinguishment of Liabilities," effective for transfers occurring
after December 31, 1996. In December 1996, Statement No. 127 was issued
which deferred the effective date of certain provisions of Statement No.
125 for transactions occurring after December 31, 1997. The impact of
adoption will not be material to the Company's financial position or
results of operations.
In February 1997, the Financial Accounting Standards Board
issued Statement No. 128, "Earnings Per Share," effective for financial
statements issued for periods ending after December 15, 1997, including
interim periods. Statement No. 128 simplifies the standards for computing
earnings per share and makes them comparable to international earnings
per share standards. The Statement also requires restatement of all
prior-period earnings per share data presented. The impact of adopting
Statement No. 128 will not affect the Company's financial position or results
of operations.
30
Item 8. Financial Statements and Supplementary Data.
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
and Stockholders, Legg Mason, Inc.
We have audited the accompanying consolidated statements of
financial condition of Legg Mason, Inc. and Subsidiaries as of
March 31, 1997 and 1996, and the related consolidated statements of
earnings, changes in stockholders' equity and cash flows for each of the
three years in the period ended March 31, 1997. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements
based on our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating
the overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Legg Mason, Inc. and Subsidiaries as of March 31, 1997 and 1996, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended March 31, 1997, in conformity with generally
accepted accounting principles.
/s/ COOPERS & LYBRAND L.L.P.
Baltimore, Maryland
May 2, 1997
31
CONSOLIDATED STATEMENTS OF EARNINGS
(Dollars in thousands except per share amounts)
Years ended March 31,
1997 1996 1995
REVENUES
Commissions $189,980 $169,181 $122,976
Principal transactions 73,181 65,870 59,470
Investment advisory and related fees 183,401 144,790 102,518
Investment banking 72,062 43,328 34,653
Interest 84,076 57,098 39,697
Other 37,006 35,776 29,751
639,706 516,043 389,065
EXPENSES
Compensation and benefits 362,876 299,562 230,483
Occupancy and equipment rental 43,043 36,403 30,855
Communications 30,528 28,081 26,519
Floor brokerage and clearing fees 5,912 5,063 5,467
Interest 43,357 26,177 17,237
Other 58,788 56,903 50,801
544,504 452,189 361,362
EARNINGS BEFORE INCOME TAXES 95,202 63,854 27,703
Income taxes 38,609 25,987 11,436
NET EARNINGS $ 56,593 $ 37,867 $ 16,267
EARNINGS PER COMMON SHARE
Primary $ 3.13 $ 2.48 $ 1.17
Fully diluted $ 2.97 $ 2.15 $ 1.05
See notes to consolidated financial statements.
32
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in thousands)
March 31,
1997 1996
ASSETS
Cash and cash equivalents $ 150,976 $ 89,378
Cash and securities segregated
for regulatory purposes 442,305 168,859
Resale agreements 132,801 108,413
Receivable from customers 527,456 398,375
Securities borrowed 263,612 196,569
Securities owned, at market value 78,862 84,219
Investment securities, at market value 66,983 83,497
Equipment, leasehold improvements
and property, net 35,809 33,339
Intangible assets 61,423 67,370
Other 118,741 84,481
$1,878,968 $1,314,500
LIABILITES AND STOCKHOLDERS' EQUITY
Liabilities
Payable to customers $ 960,646 $ 564,698
Payable to brokers and dealers 7,112 3,854
Securities loaned 250,804 170,829
Short-term borrowings 13,400 6,800
Securities sold, but not yet purchased,
at market value 12,507 10,693
Accrued compensation 58,893 41,168
Other 57,396 50,018
Senior notes 99,581 99,534
COMMITMENTS AND CONTINGENCIES 1,460,339 947,594
SUBORDINATED LIABILITIES ---- 68,000
STOCKHOLDERS' EQUITY
Common stock, par value $.10; authorized
100,000,000 shares; issued 18,271,436
shares in 1997 and 15,383,493 in 1996 1,827 1,538
Additional paid-in capital 192,817 120,960
Retained earnings 223,752 176,098
Net unrealized appreciation on
investment securities 233 310
418,629 298,906
$1,878,968 $1,314,500
See notes to consolidated financial statements.
33
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Dollars in thousands except share amounts)
Net Unrealized
Appreciation
Additional on Total
Common Stock Paid-in Retained Investment Stockholders'
Shares Amount Capital Earnings Securities Equity
Balance March 31, 1994 13,058,664 $1,306 $ 79,986 $134,384 ---- $215,676
Issuance of common stock 522,974 52 3,482 3,534
Repurchase of common stock (7,500) (1) (140) (141)
Dividends declared
($.43 per share) (5,243) (5,243)
Net unrealized gain on
investment securities $ 358 358
Pro forma tax provision
of pooled entity 6 6
Net earnings 16,267 16,267
Balance March 31, 1995 13,574,138 $1,357 $ 83,328 $145,414 $ 358 $230,457
Issuance of common stock 227,187 23 3,864 3,887
Conversion of
subordinated debentures 1,582,168 158 33,768 33,926
Dividends declared
($.47 per share) (6,557) (6,557)
Net unrealized loss
on investment securities (48) (48)
Pro forma tax provision
of pooled entity (626) (626)
Net earnings 37,867 37,867
Balance March 31, 1996 15,383,493 $1,538 $120,960 $176,098 $ 310 $298,906
Issuance of common stock 253,428 25 4,951 4,976
Conversion of
subordinated debentures 2,634,515 264 66,906 67,170
Dividends declared
($.51 per share) (8,939) (8,939)
Net unrealized loss
on investment securities (77) (77)
Net earnings 56,593 56,593
BALANCE MARCH 31, 1997 18,271,436 $1,827 $192,817 $223,752 $ 233 $418,629
See notes to consolidated financial statements.
34
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Years ended March 31,
1997 1996 1995
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings $ 56,593 $ 37,867 $ 16,267
Noncash items included in earnings:
Depreciation and amortization 17,213 14,245 10,745
Pro forma tax provision of pooled entity (626) 6
Deferred income taxes (3,417) (2,978) (913)
70,389 48,508 26,105
(Increase) decrease in assets excluding acquisitions:
Cash and securities segregated for regulatory purposes (273,446) (137,831) 96,472
Receivable from customers (129,081) (88,292) (54,805)
Securities borrowed (67,043) (76,167) (24,372)
Securities owned 5,357 (32,329) 5,727
Other (35,112) (16,433) 8,322
Increase (decrease) in liabilities excluding acquisitions:
Payable to customers 395,948 242,063 21,627
Payable to brokers and dealers 3,258 (75) (6,700)
Securities loaned 79,975 66,525 (3,761)
Securities sold, but not yet purchased 1,814 4,331 (2,151)
Accrued compensation 17,725 25,302 215
Other 10,243 14,290 (3,921)
CASH PROVIDED BY OPERATING ACTIVITIES 80,027 49,892 62,758
CASH FLOWS FROM INVESTING ACTIVITIES:
Payments for:
Equipment, leasehold improvements and property (19,016) (12,777) (13,888)
Intangible assets (653) (389) (554)
Acquisitions, net of cash acquired (2,674) (53,808)
Sale of property 6,154
Net (increase) decrease in resale agreements (24,387) (44,453) 33,990
Purchases of investment securities (178,858) (86,534) (29,320)
Proceeds from sales and maturities of
investment securities 195,196 22,933 39,114
CASH USED FOR INVESTING ACTIVITIES (21,564) (123,894) (24,466)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in short-term borrowings 6,600 5,995 (15,691)
Repayment of subordinated liabilities (29) (69)
Issuance of senior notes 99,528
Issuance of common stock 4,976 3,887 2,228
Repurchase of common stock (141)
Dividends paid (8,412) (6,058) (5,068)
CASH PROVIDED BY (USED FOR) FINANCING ACTIVITIES 3,135 103,283 (18,672)
NET INCREASE IN CASH AND CASH EQUIVALENTS 61,598 29,281 19,620
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 89,378 60,097 40,477
CASH AND CASH EQUIVALENTS AT END OF YEAR $150,976 $ 89,378 $ 60,097
See notes to consolidated financial statements.
35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands except per share amounts)
1. Summary of Significant Accounting Policies
Basis of Presentation
Legg Mason, Inc. ("Parent") and its wholly-owned subsidiaries
(collectively, the "Company") are principally engaged in providing securities
brokerage, investment advisory, investment banking and commercial mortgage
banking services to individuals, institutions, corporations and
municipalities. The Company's profitability is sensitive to a variety of
factors including the volume of trading in securities, the volatility and
general level of market prices, and the demand for investment banking and
mortgage banking services.
The consolidated financial statements include the accounts of
the Parent and its wholly-owned subsidiaries. All material intercompany
balances and transactions have been eliminated. Where appropriate, prior
years' financial statements have been reclassified to conform with the
1997 presentation.
The consolidated financial statements are prepared in accordance
with generally accepted accounting principles which require management to
make assumptions and estimates that affect the amounts and disclosures
presented. Actual amounts could differ from those estimates.
Cash and Cash Equivalents
Cash equivalents are highly liquid investments with original
maturities of less than 90 days, other than those held for sale in the
ordinary course of business.
Resale Agreements
The Company invests in short-term resale agreements collateralized
by U.S. government and agency securities. The market value of the underlying
collateral as determined daily, plus accrued interest thereon, must exceed
the face amount of the transaction. It is the Company's policy to have such
underlying collateral deposited in the Company's accounts at its custodian
banks. Resale agreements are carried at the amounts at which the securities
will be subsequently resold as specified in the agreements, plus accrued
interest.
36
Securities
Securities transactions are recorded on a settlement date basis
which does not differ materially from a trade date basis. Commission revenues
and related expenses for unsettled transactions are recorded on a trade date
basis. Securities owned by the Company's broker-dealer subsidiaries, both for
trading and investing, are valued at market and resulting unrealized gains
and losses are reflected in earnings. Investment securities of the Parent
and its non-broker-dealer subsidiaries held as available-for-sale are valued
at market and resulting unrealized gains and losses are reflected in
stockholders' equity.
Depreciation and Amortization
Equipment, leasehold improvements and property are reported at
cost, net of accumulated depreciation and amortization of $43,013 and
$38,180 at March 31, 1997 and 1996, respectively.
Depreciation and amortization are determined by use of the
straight line method over the estimated useful life of the asset or the
remaining life of the lease. Maintenance and repair costs are expensed
as incurred.
Intangible Assets
Intangible assets consist principally of goodwill, asset
management and mortgage servicing contracts, attributable to business
combinations. Intangibles are amortized using straight line and accelerated
methods over periods not exceeding forty years. Accumulated amortization
at March 31, 1997 and 1996 was $54,726 and $49,196, respectively.
The Company periodically reviews its accounting for goodwill
and other intangible assets, considering such factors as historical
profitability and projected operating cash flows, to determine that the
assets are realizable and the amortization periods are appropriate.
Fair Value of Financial Instruments
At March 31, 1997 and 1996, substantially all financial
instruments are carried at fair value or amounts which approximate fair
value. Fair values of Senior Notes are disclosed in Note 7.
37
Investment Advisory and Related Fees
The Company earns investment advisory fees on assets in accounts
managed by its subsidiaries, distribution fees on assets in the Company-
sponsored mutual funds and asset-based fees on various types of single-fee
brokerage accounts.
Earnings Per Share
Primary earnings per share are computed by dividing net earnings
by the weighted average number of shares outstanding and dilutive common
stock equivalents. The Company's common stock equivalents are shares of
common stock issuable under various stock option plans.
Fully diluted earnings per share assumes both the exercise of
dilutive common stock equivalents and conversion of subordinated debentures.
The weighted average number of shares is as follows:
Years ended March 31,
1997 1996 1995
Primary 18,058,511 15,273,113 13,853,330
Fully diluted 19,132,714 18,533,089 18,177,937
2. Business Combinations
On January 2, 1996, the Company issued 1,324,091 shares of its
common stock to acquire Bartlett & Co. ("Bartlett"), an investment management
firm that manages equity, fixed income, and balanced accounts for high net
worth individuals and institutions.
The acquisition was accounted for as a pooling of interests.
Accordingly, the consolidated financial statements have been restated to
include the accounts of Bartlett for all periods presented. Bartlett's
pre-acquisition operating results include pro forma income tax provisions
of $(626) for the nine months ended December 31, 1995 and $6 for the year
ended March 31, 1995. The provisions, not applicable to Bartlett in its
status as a Subchapter S Corporation, were included to provide comparability
with the Company's historical operating results.
On February 13, 1996, the Company acquired Lehman Brothers
Global Asset Management Limited (since renamed Western Asset Global
Management Limited), an investment management firm that specializes in
international fixed-income and currency management. The acquisition,
which was not material to the Company's results of operations and financial
position, was accounted for under the purchase method of accounting.
38
Accordingly, the results of operations have been included from the date of
acquisition.
On January 5, 1995, the Company acquired the assets of
Batterymarch Financial Management ("Batterymarch"), an investment advisory
firm that manages equity portfolios for institutional clients. The Company
paid $54,141 cash at closing. An additional payment, due in early 1998 and
based on Batterymarch's achievement of specified revenue levels for calendar
1997, could increase the total consideration to a maximum of $120,000. Based
on current revenues, it is anticipated that no additional payment will be
required. The acquisition was accounted for under the purchase method of
accounting; accordingly, the total purchase price was allocated to the net
assets acquired, principally goodwill and asset management contracts, based
on estimated fair market values. The results of operations have been included
in the consolidated financial statements from the date of acquisition.
3. Receivable from and Payable to Customers
Receivable from and payable to customers represent balances
arising from cash and margin transactions. Securities owned by customers
are held as collateral for the receivable balances. Included in payable to
customers are free credit balances of approximately $867,413 as of
March 31, 1997, and $463,477 as of March 31, 1996. The Company pays interest
on certain customer free credit balances held for investment purposes.
4. Securities, at Market
Securities positions consist of the following at
March 31:
Securities owned
1997 1996
U.S. government and federal agencies $22,564 $17,735
State and municipal bonds 27,228 29,586
Corporate debt and equity 29,070 36,898
$78,862 $84,219
Securities sold,
but not yet purchased
1997 1996
U.S. government and federal agencies $ 6,568 $ 2,638
State and municipal bonds 324 259
Corporate debt and equity 5,615 7,796
$12,507 $10,693
39
5. Investment Securities
The Company's investment securities, including the type and maturity
range for available-for-sale securities, are as follows:
at March 31, 1997
Cost/ Gross Gross Fair
amortized unrealized unrealized market
cost gains losses value
Non-broker-dealer:
Corporate debt:
within one year $ 8,954 $ (60) $ 8,894
one to five years 1,997 (6) 1,991
U.S. governments:
within one year 41,121 (10) 41,111
one to five years
Other securities:
one to five years
equities 2,050 $635 (156) 2,529
$54,122 $635 $ (232) $54,525
Broker-dealer 12,458
$66,983
at March 31, 1996
Cost/ Gross Gross Fair
amortized unrealized unrealized market
cost gains losses value
Non-broker-dealer:
Corporate debt:
within one year $13,916 $ (2) $13,914
one to five years 6,024 (55) 5,969
U.S. governments:
within one year 53,892 (7) 53,885
one to five years 2,501 (17) 2,484
Other securities:
one to five years 211 $ 20 (9) 222
equities 3,733 590 (4) 4,319
$80,277 $610 $ (94) $80,793
Broker-dealer 2,704
$83,497
The proceeds of debt securities held as available-for-sale which matured
during fiscal 1997 and 1996 were $192,166 and $22,546, respectively.
The proceeds of equity securities held as available-for-sale which were
sold during fiscal 1997 were $3,030 with a gross realized gain of $1.
40
6. Short-Term Borrowings
Short-term borrowings consist of loans from banks totaling
$13,400 and $6,800 at March 31, 1997 and 1996, respectively.
The Company's subsidiaries have secured and unsecured bank lines
of credit totaling $292,500 that are generally subject to termination at
either party's discretion. No borrowings were outstanding under these
agreements at March 31, 1997. At March 31, 1996, $3,800 was outstanding
under an unsecured agreement at an interest rate of 5.6%.
Together with certain subsidiaries, the Parent has jointly
entered into revolving credit agreements which permit it to borrow up to
$55,000, generally repayable within 30 days. At March 31, 1997 and 1996
the Company had $13,400 and $3,000, respectively, outstanding under these
agreements which bear interest at 6.25% and 6.07%, respectively. The
borrowings were collateralized by securities with market values of $14,500
at March 31, 1997 and $5,600 at March 31, 1996.
In addition, the Parent has a revolving credit agreement that
permits it to borrow up to $50,000, repayable generally over three years,
at floating rates. Under the terms of the agreement, the Company is required,
among other things, to maintain consolidated net worth plus subordinated
liabilities of not less than $299,626 plus 50% of consolidated annual net
earnings subsequent to March 31, 1997.
Interest payments were $45,066 in 1997, $25,543 in 1996 and
$17,307 in 1995.
7. Senior Notes
In February 1996, the Company issued $100 million principal
amount of senior notes due February 15, 2006, which bear interest at 6.5%.
The notes were sold at a discount to yield 6.57%. The fair value of the
senior notes, estimated using current market prices, was $92,375 and $95,238
at March 31, 1997 and 1996, respectively. The Company has available for
offering an additional $50 million of debt or convertible debt securities,
pursuant to a shelf registration filed in January 1996.
8. Subordinated Liabilities
At March 1996, $68,000 of 5.25% Convertible Subordinated
Debentures due May 1, 2003, were outstanding.
During fiscal 1997, the Company called for redemption the
full principal amount outstanding of its 5.25% Convertible Subordinated
Debentures. Substantially all holders converted their
41
debentures into 38.76 shares of common stock for each one thousand dollars
principal amount of the debentures (based on the conversion price of $25.80
per share of common stock), with cash paid in lieu of fractional shares.
During fiscal 1996, the Company called for redemption the
$34,487 aggregate principal amount outstanding of its 7% Convertible
Subordinated Debentures. Substantially all holders converted their
debentures into 45.96 shares of common stock for each one thousand
dollars principal amount of the debentures (based on the conversion
price of $21.76 per share of common stock), with cash paid in lieu of
fractional shares.
9. Commitments and Contingencies
The Company leases office facilities and equipment under
non-cancellable operating leases which expire on varying dates through
2011. Certain leases provide for renewal options and contain escalation
clauses providing for increased rentals. As of March 31, 1997, the
minimum annual aggregate rentals are as follows:
1998 $ 22,533
1999 19,267
2000 15,609
2001 12,469
2002 11,088
Thereafter 55,778
$136,744
Total rental expense, including cancellable equipment leases,
was $29,570, $26,503 and $24,285 for 1997, 1996 and 1995, respectively.
The Company has entered into an agreement with a service
provider which, if completed, will require the Company to make payments
of approximately $27,000 over a five year period.
The Company enters into when-issued and underwriting commitments.
Had the open transactions relating to these commitments as of March 31, 1997
been closed, the effect on the consolidated financial statements of the
Company would not have been material.
The Company and its subsidiaries have been named as defendants
in various legal actions arising primarily from securities and investment
banking activities, including certain class actions which primarily allege
violations of securities laws and seek unspecified damages which could be
substantial. While the ultimate resolution of these actions cannot be
currently determined, in the opinion of management, after consultation with
legal counsel, the actions will be resolved with no material
42
adverse effect on the consolidated financial statements of the Company.
Fiscal 1995 earnings include a charge of $2,000 ($950 after tax)
relating to the settlement of a class action litigation arising from taxable
municipal bond offerings underwritten in 1986 by one of the Company's
subsidiaries.
10. Employee Benefits
The Company, through its subsidiaries, maintains various defined
contribution plans covering substantially all employees. Discretionary
contributions charged to operations amounted to $11,574, $7,742 and $3,679
in 1997, 1996 and 1995, respectively. In addition, employees can make
voluntary contributions under certain plans.
11. Income Taxes
The Company and its subsidiaries file a consolidated federal
income tax return. The provision for income taxes consists of:
1997 1996 1995
Federal $31,489 $20,809 $ 8,826
State and local 7,120 5,178 2,610
$38,609 $25,987 $11,436
Current $42,026 $28,965 $12,349
Deferred (3,417) (2,978) (913)
$38,609 $25,987 $11,436
A reconciliation of the difference between the effective income
tax rate and the statutory federal income tax rate follows:
1997 1996 1995
Taxes at statutory rates 35.0% 35.0% 35.0%
State income taxes, net of
federal income tax benefit 4.9 5.3 6.1
Tax-exempt interest
income, net (0.6) (0.8) (1.9)
Other, net 1.3 1.2 2.1
Effective income tax rates 40.6% 40.7% 41.3%
43
Components of the Company's deferred tax assets and liabilities
are as follows:
1997 1996
Deferred tax assets:
Accrued compensation
and benefits $11,973 $ 8,213
Accrued expenses 2,761 3,027
Operating loss carryforwards 771 1,177
Amortization of
leasehold improvements 1,256 1,261
Other 2,212 1,818
Valuation allowance (1,071) (1,435)
$17,902 $14,061
Deferred tax liabilities:
Depreciation $ 1,667 $ 1,695
Deferred expenses 1,184 781
Deferred income 907 859
Other 148 147
$ 3,906 $ 3,482
At March 31, 1997 and 1996, the deferred tax valuation allowance was
primarily for benefits related to net operating losses which expire from
2004 to 2012.
Income tax payments were $45,054 in 1997, $24,792 in 1996 and $12,047
in 1995.
12. Capital Stock
At March 31, 1997, the authorized numbers of common and preferred
shares were 100,000,000 and 4,000,000, respectively. In addition, at
March 31, 1997 and 1996, there were 4,735,091 and 1,931,189 shares of common
stock reserved for issuance under the Company's stock option plans.
13. Stock Plans
Options under the Company's employee stock option plans have been
granted at prices not less than 100% of the fair market value of the shares
on the date of grant. Options granted prior to fiscal 1996 generally become
exercisable in cumulative 20% increments over five years and expire within
ten years from the date of grant. Options granted in fiscal 1997 and 1996
generally become exercisable in 25% increments over four years and expire
five years from the date of grant. At March 31, 1997, 4,250,000 shares were
authorized to be issued under the Company's employee stock option plans.
44
Transactions under the plans during the three years ending
March 31, 1997 are summarized below:
Weighted
average
Number of exercise
shares price
Options outstanding at
March 31, 1994 1,219,261 $15.37
Granted 407,307 $20.01
Exercised (73,269) $10.37
Canceled (22,905) $17.94
Options outstanding at
March 31, 1995 1,530,394 $16.81
Granted 416,800 $27.69
Exercised (213,892) $13.58
Canceled (23,560) $17.94
Options outstanding at
March 31, 1996 1,709,742 $19.85
Granted 409,850 $29.35
Exercised (197,348) $16.15
Canceled (32,080) $25.69
Options outstanding at
March 31, 1997 1,890,164 $22.19
At March 31, 1997, 1996 and 1995, options were exercisable on 810,889,
743,678, and 763,163 shares, respectively, and the weighted average exercise
prices were $17.25, $15.10 and $13.71, respectively.
The following information summarizes the Company's stock options
outstanding at March 31, 1997:
Weighted Weighted
Option average average
Exercise shares exercise remaining life
price range outstanding price (in years)
$10.00-$14.99 380,536 $11.73 2.47
$15.00-$20.99 521,243 $19.32 6.64
$21.00-$29.99 949,085 $27.49 4.63
$30.00-$41.99 39,300 $33.84 5.82
45
The following information summarizes the Company's stock options
exercisable at March 31, 1997:
Weighted
Option average
Exercise shares exercise
price range exercisable price
$10.00-$14.99 369,814 $11.64
$15.00-$20.99 259,046 $19.02
$21.00-$29.99 182,029 $26.10
The Company accounts for stock-based compensation under the
provisions of Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees," rather than the fair value method in Financial
Accounting Standards Board Statement No. 123, "Accounting for Stock-Based
Compensation." Accordingly, no compensation costs were charged to earnings
for options granted under the Company's plans. Pro forma results based on
the fair value method prescribed in Statement No. 123 are as follows:
1997 1996
Net earnings
As reported $56,593 $37,867
Pro forma $55,799 $37,448
Earnings per share
As reported:
Primary $ 3.13 $ 2.48
Fully diluted $ 2.97 $ 2.15
Pro forma:
Primary $ 3.09 $ 2.45
Fully diluted $ 2.92 $ 2.13
The weighted-average fair value of stock options granted in
fiscal 1997 and 1996, using the Black-Scholes option-pricing model, is
$7.30 and $7.86 per option share, respectively. The following
weighted-average assumptions were used in the model for grants in fiscal 1997
and 1996, respectively: expected dividend yield of 1.85% and 1.72%;
risk-free interest rate of 6.58% and 6.21%; expected volatility of 21.62% and
25.98%; and expected lives of 4.33 years and 4.83 years.
Pro forma compensation expense associated with option grants is
recognized over the vesting period. The initial impact of applying
Statement No. 123 is not representative of the potential impact on
pro forma net earnings for future years, which will include compensation
expense related to vesting of fiscal 1997, fiscal 1996 and subsequent grants.
46
The Company has also adopted the "Legg Mason 1988 Non-Employee
Director Option Plan." Options granted under the plan are immediately
exercisable at a price equal to the fair market value of the shares on the
date of grant. Options issuable under the plan, limited to 175,000 shares in
aggregate, have a term of not more than ten years from the date of grant. At
March 31, 1997, options on 105,000 shares have been granted, of which 98,000
are currently outstanding.
The Company has an Employee Stock Purchase Plan covering
substantially all employees. Shares of common stock are purchased in the
open market on behalf of participating employees, subject to a 1,625,000
total share limit under the plan. Purchases are made through payroll
deductions with the Company matching 5% of the employees' contributions.
Charges to earnings were not significant with respect to this plan.
14. Off-Balance Sheet Risk and Concentration of Credit
In the normal course of business, the Company executes, settles
and finances customer and proprietary securities transactions. These
activities expose the Company to off-balance sheet risk in the event
that customers or other parties fail to satisfy their obligations.
In accordance with industry practice, securities transactions
are recorded on settlement date, generally three business days after
trade date. Should a customer or broker fail to deliver cash or securities
as agreed, the Company may be required to purchase or sell securities at
unfavorable market prices.
The Company extends credit to customers, collateralized by cash
and securities, and subject to regulatory and internal requirements.
Customer margin transactions include sales of securities not yet purchased,
option contracts and commodity futures contracts. The Company continually
monitors margin requirements and requests customers to deposit additional
collateral or reduce positions when necessary. Such transactions expose the
Company to risk in the event that margin requirements are insufficient to
fully cover customer losses.
The Company borrows and lends securities to finance transactions
and facilitate the settlement process, utilizing both firm proprietary
positions and customer margin securities held as collateral. In addition,
the Company engages in conduit securities borrowing and lending activities
in which it acts as an agent to facilitate settlement for other institutions.
In both firm and conduit transactions, the Company deposits or receives cash
generally equal to 102% of the market value of the securities exchanged and
monitors the adequacy of collateral levels on a daily basis. The Company
periodically borrows from banks on a collateralized basis, utilizing firm
and customer margin
47
securities in compliance with Securities and Exchange Commission rules.
Should the counterparty fail to return customer securities pledged, the
Company is subject to the risk of acquiring the securities at prevailing
market prices in order to satisfy its customer obligations. The
Company sells securities it does not currently own, and is obligated to
subsequently purchase such securities at prevailing market prices. The
Company is exposed to risk of loss if securities prices increase prior
to closing the transactions.
15. Regulatory Requirements
The Company'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
March 31, 1997, the broker-dealer subsidiaries had aggregate net capital,
as defined, of $132,736 which exceeded required net capital by $120,762.
The Company's principal broker-dealer subsidiary must maintain a
separate account for the exclusive benefit of customers in accordance with
Securities and Exchange Commission Rule 15c3-3, as determined by periodic
computations. The rule allows the broker-dealer to maintain the required
amounts in cash or qualified securities.
16. Business Segment Information
The Company, through its subsidiaries, operates predominantly in
a single business segment - the securities industry. Within this segment,
the Company is primarily engaged in securities brokerage, investment
advisory and investment banking activities.
48
QUARTERLY FINANCIAL DATA
(Dollars in thousands except per share amounts)
(Unaudited)
Quarter ended
1997 Mar. 31 Dec. 31 Sept. 30 June 30
Revenues $176,308 $167,267 $147,294 $148,837
Expenses 151,767 141,767 124,119 126,851
Earnings before income taxes 24,541 25,500 23,175 21,986
Income taxes 10,044 10,200 9,279 9,086
Net earnings $ 14,497 $ 15,300 $ 13,896 $ 12,900
Earnings per share:
Primary $ .75 $ .81 $ .78 $ .80
Fully diluted $ .75 $ .80 $ .74 $ .71
1996* Mar. 31 Dec. 31 Sept. 30 June 30
Revenues $147,788 $127,549 $124,709 $115,997
Expenses 126,801 113,566 109,083 102,739
Earnings before income taxes 20,987 13,983 15,626 13,258
Income taxes 8,494 5,666 6,395 5,432
Net earnings $ 12,493 $ 8,317 $ 9,231 $ 7,826
Earnings per share:
Primary $ .78 $ .52 $ .61 $ .55
Fully diluted $ .70 $ .47 $ .52 $ .46
*Restated due to pooling of interests transaction.
49
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure.
None.
PART III
Item 10. Directors and Executive Officers of the Registrant.
The information required by this item is contained
under the caption "Election of Directors" on pages 1 through 4
of the Company's definitive proxy statement for the 1997 Annual
Meeting of Stockholders and the caption "Compliance With Section
16(a) of the Securities Exchange Act of 1934" on page 11 of such
proxy statement. Such information is incorporated herein by
reference to the proxy statement. See Part I, Item 4A of this
Report for information regarding certain executive officers of
the Company.
Item 11. Executive Compensation.
The information required by this item is contained under
the caption "Executive Compensation" on pages 6 and 7 of the Company's
definitive proxy statement for the 1997 Annual Meeting of Stockholders.
Such information is incorporated herein by reference to the proxy
statement.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information required by this item is contained under the
caption "Security Ownership of Management and Principal Stockholders"
on page 5 of the Company's definitive proxy statement for the 1997
Annual Meeting of Stockholders. Such information is incorporated
herein by reference to the proxy statement.
Item 13. Certain Relationships and Related Transactions.
The information required by this item is contained under
the caption "Certain Transactions" on page 10 of the Company's definitive
proxy statement for the 1997 Annual Meeting of Stockholders. Such
information is incorporated herein by reference to the proxy statement.
50
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a) Documents filed as a part of the report:
1. The following consolidated financial statements are included
in Item 8 of this Report:
Page Number in
this Report
Report of Independent
Accountants 30
Consolidated Statements
of Earnings 31
Consolidated Statements
of Financial Condition 32
Consolidated Statements of
Changes in Stockholders'
Equity 33
Consolidated Statements
of Cash Flows 34
Notes to Consolidated
Financial Statements 35-47
2. Financial Statement Schedules (included on pages S-1
to S-5 of this Report):
Report of Independent Accountants on
Financial Statement Schedules
Schedule I - Condensed Financial Statement
of Registrant
All other schedules to the consolidated financial statements
for which provision is made in the accounting regulations of
the Securities and Exchange Commission are not applicable or
are not required and therefore have been omitted.
51
3. Exhibits
3.1 - Articles of Incorporation of the Company,
as amended (incorporated by reference to
Form 10-Q for the quarter ended
September 30, 1996)
3.2 - By-laws of the Company 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)
4 - The Company hereby agrees, pursuant to
Item 601(b)(4)(iii)(A) of Regulation S-K,
to furnish to the Commission upon request
a copy of each instrument with respect to
the rights of holders of long-term debt of
the Company or its subsidiaries.
10.1 - Legg Mason, Inc. 1981 Incentive Stock Option
Plan, as amended through June 2, 1988
(incorporated by reference to the Company's
Annual Report on Form 10-K for the year ended
March 31, 1988)*
10.2 - Legg Mason, Inc. 1988 Non-Employee Director
Stock Option Plan (incorporated by reference
to the Company's Annual Report on Form 10-K
for the year ended March 31, 1993)*
10.3 - Legg Mason Wood Walker, Incorporated Deferred
Compensation/Phantom Stock Plan (incorporated
by reference to Registration No. 33-28609 on
Form S-8)*
10.4 - Legg Mason, Inc. 1991 Omnibus Long-Term
Compensation Plan (incorporated by reference
to Exhibit A to the definitive proxy statement
for the Company's 1991 Annual Meeting of
Stockholders)*
10.5 - Form of Option Agreement under Legg Mason, Inc.
1991 Omnibus Long-Term Compensation Plan
(incorporated by reference to the Company's
Annual
52
Report on Form 10-K for the year ended
March 31, 1993)*
10.6 - Legg Mason, Inc. Executive Incentive
Compensation Plan (incorporated by reference
to Appendix A to the definitive proxy statement
for the Company's 1995 Annual Meeting of
Stockholders)*
10.7 - Legg Mason, Inc. 1996 Equity Incentive Plan
(incorporated by reference to Appendix A to
the definitive proxy statement for the
Company's 1996 Annual Meeting of Stockholders)*
10.8 - Form of Option Agreement under Legg Mason, Inc.
1996 Equity Incentive Plan (incorporated by
reference to the Company's Annual Report on
Form 10-K for the year ended March 31, 1996)*
10.9 - Form of Non-Qualified Stock Option Agreement
under Legg Mason, Inc. 1996 Equity Incentive
Plan (incorporated by reference to Form 10-Q
for the quarter ended September 30, 1996)*
10.10- Executive Convertible Debenture Purchase and
Loan Agreement between Legg Mason, Inc. and
an Executive Officer of Legg Mason, Inc.,
dated as of August 29, 1996 (incorporated
by reference to Form 10-Q for the quarter
ended December 31, 1996)*
10.11- Legg Mason, Inc. Executive Convertible
Subordinated Debenture Due August 29, 2000
issued to an Executive Officer of Legg Mason,
Inc. (incorporated by reference to Form 10-Q
for the quarter ended December 31, 1996)*
10.12- Promissory Note of Executive Officer of Legg
Mason, Inc., dated as of August 29, 1996
(incorporated by reference to Form 10-Q for
the quarter ended December 31, 1996)*
53
10.13- Pledge Agreement by and between an Executive
Officer of Legg Mason, Inc. as Pledgor, and
Legg Mason, Inc. as Pledgee, dated as of
August 29, 1996 (incorporated by reference
to Form 10-Q for the quarter ended
December 31, 1996)*
11 - Statement regarding computation of per share
earnings, filed herewith
21 - Subsidiaries of the Company, filed herewith
23 - Consent of independent accountants, filed
herewith
27 - Financial Data Schedule, filed here- with
*These exhibits are management contracts or compensatory plans or
arrangements.
(b) No reports on Form 8-K were filed during the quarter ended
March 31, 1997.
54
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
By: /s/ Raymond A. Mason
Raymond A. Mason, Chairman
of the Board, President and
Chief Executive Officer
Date: June 27, 1997
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf
of the Registrant and in the capacities and on the dates indicated.
Signature Title Date
/s/ Raymond A. Mason Chairman of the Board, June 27, 1997
Raymond A. Mason President and Chief
Executive Officer
(Principal Executive
Officer)
/s/ F. Barry Bilson Vice President-Finance June 27, 1997
F. Barry Bilson (Principal Financial
and Accounting Officer)
/s/ John F. Curley, Jr. Director June 27, 1997
John F. Curley, Jr.
/s/ James. W. Brinkley Director June 27, 1997
James W. Brinkley
Director June , 1997
Edmund J. Cashman, Jr.
/s/ Charles A. Bacigalupo Director June 27, 1997
Charles A. Bacigalupo
55
/s/ Harry M. Ford, Jr. Director June 27, 1997
Harry M. Ford, Jr.
/s/ Nicholas J. St. George Director June 27, 1997
Nicholas J. St. George
/s/ Richard J. Himelfarb Director June 27, 1997
Richard J. Himelfarb
/s/ James E. Ukrop Director June 27, 1997
James E. Ukrop
/s/ John B. Levert, Jr. Director June 27, 1997
John B. Levert, Jr.
/s/ Harold L. Adams Director June 27, 1997
Harold L. Adams
/s/ John E. Koerner, III Director June 27, 1997
John E. Koerner, III
/s/ Roger W. Schipke Director June 27, 1997
Roger W. Schipke
/s/ W. Curtis Livingston Director June 27, 1997
W. Curtis Livingston
/s/ Edward I. O'Brien Director June 27, 1997
Edward I. O'Brien
/s/ Peter F. O'Malley Director June 27, 1997
Peter F. O'Malley
/s/ Margaret DeB. Tutwiler Director June 27, 1997
Margaret DeB. Tutwiler
/s/ William Wirth Director June 27, 1997
William Wirth