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UNITED STATES
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, 2001
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)
100 Light 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 25, 2001, the aggregate market value of the registrant's voting
stock, consisting of the registrant's common stock and the exchangeable shares
discussed below, held by non-affiliates was $2,885,535,900.
As of May 25, 2001, the number of shares outstanding of the registrant's
common stock was 63,192,901. In addition, on that date a subsidiary of the
registrant had outstanding 2,721,886 exchangeable shares which are convertible
on a one-for-one basis at any time into shares of common stock of the
registrant.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive proxy statement dated June 21, 2001
are incorporated by reference into Part III.
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Part I
Item 1. Business.
- ------ ---------
General
- -------
Legg Mason, Inc. is a holding company which, through its
subsidiaries, is principally engaged in providing asset management, securities
brokerage, investment banking and related financial services to individuals,
institutions, corporations and municipalities.
The Company's principal asset management subsidiaries are Legg
Mason Funds Management, Inc., which serves as investment advisor to or manager
of certain Company-sponsored mutual funds; Western Asset Management Company and
Western Asset Management Company Limited, which manage fixed income and currency
assets for institutional clients; Perigee Investment Counsel Inc., which is an
institutional investment manager in Canada; Brandywine Asset Management, Inc.,
which primarily manages equity portfolios for institutional clients;
Batterymarch Financial Management, Inc., which manages U.S., international and
emerging markets equity portfolios for institutional clients; Legg Mason Capital
Management, Inc., which manages equity portfolios primarily for institutional
accounts; Bartlett & Co., which manages balanced, equity and fixed income
portfolios for high net worth individuals and institutional clients; LeggMason
Investors Holdings plc, which primarily manages equity retail funds in the
United Kingdom; Barrett Associates, Inc., which is an asset manager for high net
worth individuals, families, endowments and foundations; Gray, Seifert & Co.,
Inc., which primarily manages equity portfolios for high net worth individuals
and family group, endowment and foundation clients; and Berkshire Asset
Management, Inc., which primarily manages equity and fixed income portfolios for
high net worth individuals and family groups. In addition to Legg Mason Funds
Management, all of the above firms also serve as investment advisor to Company-
sponsored mutual funds and/or other Company-sponsored investment products. On
May 29, 2001, the Company entered into an agreement to acquire all of the
ownership interests in Private Capital Management, L.P., which manages equity
assets for high net worth individuals, families, endowments, foundations and
selected institutions.
As of March 31, 2001, the Company's asset management subsidiaries
had approximately $140 billion of assets under management, of which
approximately 33% were equity assets and approximately 67% were fixed income
assets.
The Company's principal broker-dealer subsidiary is Legg Mason
Wood Walker, Incorporated ("Legg Mason Wood Walker"), a full service broker-
dealer and investment banking firm operating primarily in the Eastern and
Southern regions of the United States.
The Company's real estate finance subsidiary is Legg Mason Real
Estate Services, Inc., which is primarily engaged in commercial mortgage banking
and servicing and discretionary and non-discretionary management of commercial
real estate-related assets.
See "Item 7. Management's Discussion and Analysis of Results of
Operations and Financial Condition - Business Description" for the net revenues
and pre-tax earnings of each of the Company's business segments. See Note 16 of
Notes to Consolidated Financial Statements in Item 8 of this Report for the net
revenues and pre-tax earnings generated by the Company in each principal
geographic area in which it conducts business.
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 asset
management, broker-dealer 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.
Brokerage Offices
- -----------------
The following table reflects, as of March 31, 2001, certain information
with respect to the Company's securities brokerage offices.
Number of
Financial Number of
Location Advisors Offices
-------- -------- -------
United States:
Maryland 318 17
Pennsylvania 181 21
Virginia 141 19
North Carolina 86 11
Louisiana 83 9
Florida 79 15
Ohio 68 8
Massachusetts 63 3
New Jersey 46 6
New York 41 4
Texas 39 4
South Carolina 36 4
District of Columbia 33 1
Mississippi 30 4
Alabama 23 4
Maine 20 1
Georgia 19 1
West Virginia 14 2
Tennessee 13 2
Connecticut 12 3
Illinois 12 1
Delaware 6 1
Rhode Island 6 1
California 5 1
New Hampshire 2 1
United Kingdom:
London 8 1
Switzerland:
Geneva 6 1
------------------- -------------------
Total 1,390 146
=================== ===================
2
Revenues by Source
- ------------------
The following table sets forth certain information regarding the
revenues of the Company by source.
LEGG MASON, INC. AND SUBSIDIARIES (1)
Years Ended March 31,
----------------------------------------------------------------------------
2001 2000 1999
---- ---- ----
(Dollars in thousands)
Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ -------
Investment Advisory and
Related Fees $ 653,992 48.1% $ 563,463 44.5% $ 414,732 42.5%
Commissions:
Listed and Over-the-
Counter 217,769 16.0 229,930 18.2 187,560 19.3
Mutual Funds 90,363 6.6 82,949 6.6 57,586 5.9
Insurance and Annuities 40,931 3.0 40,247 3.2 26,172 2.7
Options 9,499 0.7 9,761 0.7 7,818 0.8
----------- ---------- ----------- ---------- ------------ ----------
Total 358,562 26.3 362,887 28.7 279,136 28.7
Principal Transactions (2)
Customer Related:
Government and Agency 17,340 1.3 16,783 1.3 17,631 1.8
Municipal 34,178 2.5 39,244 3.1 22,387 2.3
Corporate Debt 23,723 1.7 21,157 1.7 15,580 1.6
Equities 39,716 2.9 36,183 2.9 26,976 2.7
----------- ---------- ----------- ---------- ------------ ----------
114,957 8.4 113,367 9.0 82,574 8.4
Dealer Related:
Government and Agency 2,406 0.2 2,327 0.2 2,575 0.2
Municipal 977 0.1 932 0.1 816 0.1
Corporate Debt 1,837 0.2 405 0.0 1,645 0.2
Equities 4,379 0.3 9,236 0.7 6,495 0.7
----------- ---------- ----------- ---------- ------------ ----------
9,599 0.8 12,900 1.0 11,531 1.2
----------- ---------- ----------- ---------- ------------ ----------
Total 124,556 9.2 126,267 10.0 94,105 9.6
Investment Banking:
Corporate 59,607 4.4 60,792 4.8 66,640 6.8
Municipal 6,270 0.4 8,113 0.7 9,478 1.0
----------- ---------- ----------- ---------- ------------ ----------
Total 65,877 4.8 68,905 5.5 76,118 7.8
Interest Income 282,201 20.7 223,030 17.6 160,433 16.4
Other (3) 51,065 3.8 55,033 4.3 46,146 4.7
----------- ---------- ----------- ---------- ------------ ----------
Total Revenues 1,536,253 112.9 1,399,585 110.6 1,070,670 109.7
Interest Expense 175,389 12.9 134,382 10.6 94,974 9.7
------------ ---------- ----------- ---------- ------------ ----------
Net Revenues $ 1,360,864 100.0% $1,265,203 100.0% $ 975,696 100.0%
============ ========== =========== ========== ============ ==========
(1) All financial information has been restated for the acquisition, on a
pooling of interests basis, of Perigee Inc. on May 26, 2000.
(2) 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.
(3) Includes revenues from commercial mortgage servicing and commercial loan
originations in fiscal year 2001, 2000 and 1999 of $20,648, $23,176 and
$22,618, respectively.
3
Asset Management Business Segment
- ---------------------------------
The Asset Management business segment provides investment advisory
services to Company-sponsored mutual funds and asset management for
institutional and individual clients.
Company-Sponsored Mutual Funds
------------------------------
Through various subsidiaries, the Company 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, 2001 and 2000, the aggregate net assets of all of these proprietary funds
were approximately $27.3 billion and $25.4 billion, respectively.
For the fiscal years ended March 31, 2001, 2000 and 1999, the Company
earned approximately $168.2 million, $158.8 million and $102.7 million,
respectively, in asset-based sales charges from its proprietary mutual funds and
offshore investment funds, which are included in the Private Client business
segment.
Asset Management Services
-------------------------
Legg Mason Funds Management, Inc. serves as investment advisor to or
manager of certain Company-sponsored mutual funds. In August 2000, the asset
management business of Legg Mason Fund Adviser was transferred to Legg Mason
Funds Management. At March 31, 2001 and 2000, Legg Mason Funds Management
managed assets with a value of approximately $15.8 billion and $18.2 billion,
respectively. In addition, all of the firms described in the following
paragraphs also serve as investment advisor to Company-sponsored mutual funds
and/or other Company-sponsored investment products. The amounts indicated as
assets under management by those firms include the assets in such funds and/or
products and exclude assets subadvised by third parties.
Western Asset Management Company manages fixed income and currency
assets for institutional clients. At March 31, 2001 and 2000, Western Asset
managed assets with a value of approximately $73.9 billion and $58.9 billion,
respectively.
Western Asset Management Company Limited manages international fixed
income and currency assets for institutional clients. At March 31, 2001 and
2000, Western Asset Management Company Limited managed assets with a value of
approximately $6.8 billion and $4.3 billion, respectively.
Perigee Investment Counsel Inc., which was acquired in May 2000, is an
institutional investment manager in Canada. At March 31, 2001, Perigee managed
assets with a value of approximately $12.3 billion.
Brandywine Asset Management, Inc. primarily manages equity portfolios
for institutional and, through wrap accounts, high net worth individual clients.
At March 31, 2001 and 2000, Brandywine managed assets with a value of
approximately $6.7 billion and $6.5 billion, respectively.
Batterymarch Financial Management, Inc. manages U.S., international
and emerging markets equity portfolios for institutional clients. At March 31,
2001 and 2000, Batterymarch managed assets with a value of approximately $5.6
billion and $6.8 billion, respectively.
Legg Mason Capital Management, Inc. manages equity portfolios
primarily for institutional accounts. At March 31, 2001 and 2000, this
subsidiary managed assets with a value of approximately $5.2 billion and $6.6
billion, respectively. In June 2000, the fixed income portfolios (aggregating
approximately $1.2 billion) management team and fund advisory contracts of Legg
Mason Capital Management were transferred to Legg Mason Trust, fsb.
4
Bartlett & Co. manages balanced, equity and fixed income portfolios
for high net worth individuals and institutional clients. At March 31, 2001 and
2000, Bartlett managed assets with a value of approximately $2.4 billion and
$2.7 billion, respectively.
LeggMason Investors Holdings plc primarily manages equity retail funds
in the United Kingdom. At March 31, 2001 and 2000, LeggMason Investors managed
assets with a value of approximately $1.8 billion and $1.6 billion,
respectively.
Barrett Associates, Inc., approximately 70% of the outstanding stock
of which was acquired in February 2001, primarily manages assets for high net
worth individuals, families, endowments and foundations. At March 31, 2001,
Barrett managed assets with a value of approximately $1.5 billion.
Gray, Seifert & Co., Inc. primarily manages equity portfolios for high
net worth individuals and family groups, endowments and foundations. At March
31, 2001 and 2000, Gray Seifert managed assets with a value of approximately
$0.8 billion and $1.1 billion, respectively.
Berkshire Asset Management, Inc. primarily manages equity and fixed
income portfolios for high net worth individuals and family groups. At March 31,
2001 and 2000, Berkshire managed assets with a value of approximately $500
million and $600 million, respectively.
The Company has revenue sharing agreements with Legg Mason Funds
Management, Western Asset Management Company, Brandywine, Bartlett, Gray
Seifert, Barrett and Berkshire and/or certain of their key officers pursuant to
which a specified percentage of the subsidiary's revenues is required to be
distributed to Legg Mason, Inc., and the balance of the revenues is retained to
pay operating expenses, including salaries and bonuses, with specific expense
and compensation allocations being determined by the subsidiary's management.
On May 29, 2001, the Company agreed to acquire all of the ownership
interests in Private Capital Management, L.P. ("PCM") and an affiliated entity.
PCM, which is privately owned, manages equity assets for high net worth
individuals, families, endowments, foundations and selected institutions. At
March 31, 2001, PCM managed assets with a value of approximately $7.1 billion.
The Company owns 50% of a joint venture with Bingham Dana LLP, a
Boston-based law firm. At March 31, 2001 and 2000, this joint venture, Bingham
Legg Advisers LLC, managed assets with a value of approximately $1.5 billion. In
addition, the Company owns 50% of a joint venture with one of its employees that
manages an equity mutual fund. As of March 31, 2001, this mutual fund had assets
with a value of approximately $1.3 billion.
Other Services
--------------
Legg Mason Trust, fsb, a federally chartered unitary thrift
institution with authority to exercise trust powers, provides services as a
trustee for trusts established by the Company's individual and employee benefit
plan clients and manages fixed income and equity assets. The Company provides
brokerage and asset management services for a significant portion of the assets
held in Legg Mason Trust's accounts. In June 2000, the fixed income portfolios
(aggregating approximately $1.2 billion), management team and fund advisory
contracts of Legg Mason Capital Management were transferred to Legg Mason Trust.
As of March 31, 2001, Legg Mason Trust managed assets with a value of
approximately $1.6 billion (excluding assets managed for the Company).
Private Client Business Segment
- -------------------------------
The Private Client business segment consists principally of the
operations of Legg Mason Wood Walker and distributes a wide range of financial
products through its branch distribution network, including equity and fixed
income securities, proprietary and non-affiliated mutual funds and annuities.
5
Private Client Securities Business
----------------------------------
For the fiscal years ended March 31, 2001, 2000 and 1999, revenues
derived from securities transactions for individual investors (excluding
interest on margin accounts) constituted approximately 79%, 80% and 82%,
respectively, of total revenues from securities transactions and 29%, 32% and
33%, respectively, of the Company's net revenues. Management believes that such
services will continue to be a significant source of revenues in the foreseeable
future, although the percentage of net revenues may continue to decrease
primarily as a result of increases in asset management 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 commission is charged on a transaction-by-transaction basis. This single
fee covers all execution and advisory services, including advisory services
provided by the Company's asset management affiliates and selected independent
advisory firms. The Company also provides asset allocation and advisor
performance and selection consultation services. 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 major distributors that offer mutual fund shares
through broker-dealers. In addition, the Company sells shares of Company-
sponsored mutual funds through its retail sales network. See "Asset Management
Business Segment -- 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, New York
Stock Exchange, Inc. ("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 risks 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 prime rate plus or minus an additional amount that varies depending upon
the amount of the customer's average debit balance. Interest income derived from
these sources constituted approximately 8%, 6% and 6% of the Company's net
revenues for the fiscal years ended March 31, 2001, 2000 and 1999, respectively.
Interest is also earned on securities owned by the Company and on operating and
segregated cash balances.
Free credit balances (excess funds held by customers in their
brokerage accounts) are the principal source 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 2001, Legg Mason
Wood Walker paid interest on approximately 90% of customer free credit balances.
Insurance Brokerage and Financial Planning
------------------------------------------
Substantially all 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. See "Revenues by
Source" for information regarding revenues generated by insurance brokerage
activities.
6
Other Services
--------------
At March 31, 2001, the Company served as a non-bank custodian for
approximately 352,000 IRA's, 29,000 Simplified Employee Pension Plans and 15,000
Qualified Plans.
Registrations and Exchange Memberships
--------------------------------------
Legg Mason Wood Walker is registered as a broker-dealer with the
Securities and Exchange Commission ("SEC"), is a member of the NYSE, the
American Stock Exchange, the National Association of Securities Dealers, Inc.
("NASD") and the Securities Investors Protection Corporation ("SIPC"), and is
registered as a futures commission merchant with the Commodity Futures Trading
Commission. In addition, Legg Mason Wood Walker is a member of the Philadelphia,
Pacific, Cincinnati, Boston and Chicago stock exchanges.
Capital Markets Business Segment
- --------------------------------
The Capital Markets business segment, which is conducted primarily
through Legg Mason Wood Walker, consists of the Company's equity and fixed
income institutional sales and trading, syndicate, and corporate and public
finance activities.
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 providing 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 offers 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,
2001, 2000 and 1999, revenues derived from securities transactions for
institutional investors constituted approximately 21%, 20% and 18%,
respectively, of total revenues from securities transactions and 8%, 8% and 7%
of the Company's net revenues.
Principal Transactions
----------------------
The Company makes primary markets in equity securities that are traded
on the Nasdaq Stock Market. The Company is also an active market maker and
distributor of municipal bonds, particularly bonds issued by municipalities
located in the Mid-Atlantic and Southern regions.
As of March 31, 2001, the Company made markets in equity securities of
approximately 250 corporations, including corporations for which the Company has
acted as a managing or co-managing underwriter. The Company has 49 traders
involved in trading corporate equity and debt securities, 15 in trading
municipal securities, 6 in trading government securities and 6 in trading
mortgage-backed securities.
The Company's market-making activities are also conducted with other
dealers, and with institutional and individual customers of its branch office
system. Mark-ups and mark-downs from market-making activities are allocated to
the Private Client business segment when the transaction involves an individual
client. 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,
7
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.
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 and municipal offerings.
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
--------- --------- --------- ---------
1996 33 258 $3,808,000,000 $ 5,555,638,000
1997 76 224 8,453,000,000 7,208,000,000
1998 45 223 8,090,054,000 8,381,696,000
1999 40 158 5,270,873,000 10,167,029,000
2000 25 158 4,821,910,000 4,350,577,000
Underwriting Participations
------------------------------------------------------------
Calendar Year Number of Issues Amount of Participation
- ------------- ---------------- -----------------------
Corporate Municipal Corporate Municipal
--------- --------- --------- ---------
1996 427 246 $1,313,233,000 $ 587,548,000
1997 298 198 1,380,000,000 936,668,000
1998 153 237 827,443,000 1,476,674,000
1999 206 159 697,336,000 1,118,887,000
2000 146 162 705,899,000 409,059,000
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 provision of financial advisory services to
corporate and municipal clients.
At March 31, 2001, the Company had 115 professionals engaged in
investment banking activities, including 78 in corporate finance and 37 in
municipal finance.
8
Merchant Banking
----------------
Legg Mason Merchant Banking, Inc. manages private equity funds
sponsored by the Company. As of March 31, 2001, Legg Mason Merchant Banking,
Inc. managed Legg Mason Capital Partners, L.P., a private equity fund raised by
the Company in September 1996 which has commitments for approximately $41
million in capital, and Legg Mason Capital Partners II, L.P., a private equity
fund raised in February 2000 which has commitments for approximately $100
million in capital.
Other Business Segment
- ----------------------
The Other businesses are principally the Company's real estate service
business, conducted through Legg Mason Real Estate Services, Inc.
Mortgage Banking and Real Estate Services
-----------------------------------------
Legg Mason Real Estate Services, Inc. ("LMRES") is engaged in the
commercial mortgage banking business. The firm originates, structures, places
and services commercial mortgages on income-producing properties for insurance
companies, pension funds and other investors. LMRES is also engaged in the
business of discretionary and non-discretionary management of commercial real
estate-related assets for institutional clients. 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.
As of March 31, 2001 and 2000, the commercial mortgage servicing
portfolio of LMRES was $7.6 billion and $9.4 billion, respectively.
Research
- --------
The Company employs 42 analysts who develop investment recommendations
and market information with respect to companies and industries. Legg Mason Wood
Walker's research has focused on 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. The Company's equity
research also focuses on companies in certain business sectors, including
companies in the biotechnology, consumer services, financial services,
industrial, real estate investment trust, technology and telecommunications
sectors. The Company's research services are supplemented by research services
purchased from outside firms.
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
important in attracting and retaining institutional and individual brokerage
clients.
Administration
- --------------
Administrative and operations personnel are responsible for the
processing of securities transactions; receipt, identification and delivery of
funds and securities; internal financial controls; office services; custody of
customers' securities; and the handling of margin accounts. At March 31, 2001,
the Company had approximately 335 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. 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
9
regulations. Failure to keep current and accurate books and records can render
the Company liable to disciplinary action by governmental and self-regulatory
authorities, as well as to claims by its clients.
Legg Mason Wood Walker executes and clears securities transactions as
a member of the NYSE and various regional exchanges, and is a participant in
both The Depository Trust Company and National Securities Clearing Corporation.
Legg Mason Wood Walker also provides clearing services to affiliated and
unaffiliated broker-dealers.
During the past several years, the Company has increased its staff and
expenditures on technology, particularly as it relates to expanding its client
support and building new business opportunities using the Internet.
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.
Employees
- ---------
At March 31, 2001, the Company had approximately 5,380 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 asset management firms and broker-dealers,
and commercial banks and thrift institutions. Many of these organizations have
substantially more personnel and greater financial resources than the Company.
Discount brokerage firms oriented to the individual investor market, including
firms affiliated with banks and mutual fund organizations and on-line brokerage
firms, are devoting substantial funds to advertising and 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 Financial Services Industry -- Industry Changes and
Competitive Factors."
Regulation
- ----------
The financial services 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. Financial
services 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 offices.
10
The Company's asset management subsidiaries and the Company-sponsored
mutual funds are subject to extensive regulation. The U.S. asset management
subsidiaries of the Company are registered as investment advisers with the SEC.
The U.S. asset management subsidiaries are also required to make notice filings
in certain states. Virtually all aspects of the asset management business are
subject to various federal and state laws and regulations. These laws and
regulations are primarily intended to benefit the asset management clients and
generally grant supervisory agencies and bodies broad administrative powers,
including the power to limit or restrict an investment advisor from conducting
its asset management business in the event that it fails to comply with such
laws and regulations. Possible sanctions which may be imposed for such failure
include the suspension of individual employees, limitations on the asset
management subsidiary engaging in the asset management business for specified
periods of time, the revocation of registrations, other censures and fines. A
regulatory proceeding, regardless of whether it results in a sanction, can
require substantial expenditures and can have an adverse effect on the
reputation of an asset manager.
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. 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. 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 broker-dealer subsidiaries are required by federal law
to belong to the SIPC. When the SIPC fund falls below a certain amount, members
are required to pay annual assessments of up to 1% of adjusted gross revenues.
As a result of adequate fund levels, each of the Company's broker-dealer
subsidiaries was required to pay the minimum annual assessment of $150 in fiscal
2001. 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 a bond 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.
Rule 15c3-1, 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
Rule 15c3-1. However, its broker-dealer subsidiaries are subject to Rule 15c3-
1, and a provision of Rule 15c3-1 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 Rule 15c3-1. As
of March 31, 2001, the Company's broker-dealer subsidiaries had aggregate net
capital of $291 million, which exceeded the minimum net capital requirements by
$269 million.
11
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. As of March 31, 2001, Legg
Mason Wood Walker's net capital was 26% of its 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 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, 2001, Legg Mason
Wood Walker had $35 million of Subordinated Liabilities outstanding, due to Legg
Mason, Inc. The Subordinated Liabilities may, with the prior written consent of
the NYSE, be prepaid in whole or in part at any time after such Subordinated
Liabilities have 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 Financial Services Industry
- -----------------------------------------------------------------
The financial services 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. As used in this section, the
terms "we," "us" and "our" refer to Legg Mason, Inc. and its subsidiaries.
Importance of Investment Performance
------------------------------------
We believe that investment performance is one of the most important
factors affecting the growth of assets under management for a company in the
asset management business. Poor investment performance could impair the revenues
and growth of a company like us because:
. existing clients might withdraw funds in favor of better performing
products, which would result in lower investment advisory fees; or
. the company's ability to attract funds from existing and new clients
might diminish.
If revenues decline without a commensurate reduction in expenses, net
income will be reduced.
Assets Under Management May Be Withdrawn
----------------------------------------
Investment advisory and administrative contracts are generally
terminable at will or upon relatively short notice, and mutual fund investors
may redeem their investments in the funds at any time without prior notice.
Institutional and individual clients can terminate their relationships with an
asset manager, reduce the
12
aggregate amount of assets under management, or shift their funds to other types
of accounts with different rate structures for any number of reasons, including
investment performance, changes in prevailing interest rates, loss of key
investment management personnel, and financial market performance. In a
declining stock market the pace of mutual fund accelerate. Poor performance
relative to other investment management firms tends to result in decreased
purchases of fund shares, increased redemptions of fund shares, and the loss of
institutional or individual accounts. The decrease in revenues that could result
from any such event could have a material adverse effect on our business.
Fluctuating Securities Volume and Prices
----------------------------------------
There are substantial fluctuations in volume and price levels of
securities transactions in the financial services industry. These fluctuations
can occur on a daily basis and over longer periods as a result of national and
international economic and political events, and broad trends in business and
finance, as well as interest rate movements. Reduced volume and prices generally
result in lower brokerage and investment banking revenues, losses from trading
as principal and from underwriting, and loss or reduction in incentive and
performance fees. Periods of reduced volume will adversely affect profitability
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. These risks are particularly high during
periods of rapidly declining markets because a market decline could reduce
collateral value below the amount of a customer's indebtedness. The business
cycle of our different operations and subsidiaries may occur contemporaneously.
Consequently, the effect of an economic downturn may have a magnified negative
effect on our business. In a period of reduced margin usage by clients, the
interest profit of a securities firm may be adversely affected. In the past,
heavy trading volume has caused clearance and processing problems for securities
firms, and this could occur in the future. In addition, securities firms face
risk of loss from errors that can occur in the execution and settlement process.
See "Administration."
A large portion of our revenues are derived from investment advisory
contracts with clients. Under these contracts, the investment advisory fees we
receive are typically based on the market value of assets under management.
Accordingly, a decline in the prices of securities generally may cause our
revenues and income to decline by:
. causing the value of our assets under management to decrease, which
would result in lower investment advisory fees; or
. causing our clients to withdraw funds in favor of investments they
perceive offer greater opportunity or lower risk, which would also
result in lower investment advisory fees.
If our revenues decline without a commensurate reduction in our
expenses, our net income will be reduced.
Industry Changes and Competitive Factors
----------------------------------------
The financial services industry has had considerable consolidation as
numerous financial services firms have either been acquired by other financial
services firms or ceased operations. In many cases, this has resulted in firms
with greater financial resources than us. In addition, a number of heavily
capitalized companies that were not previously engaged in the financial services
business have made investments in and acquired financial services firms.
Increasing competitive pressures in the financial services industry require
firms of our size to offer to their customers many of the services that are
provided by much larger firms that have substantially greater resources than us.
A sizable number of new asset management firms and mutual funds have been
established in recent years, increasing competition in that area of our
activities.
An increasing number of firms that offer discount brokerage services
to individual investors have been established in recent years. Included in
these firms are on-line brokerage firms and affiliates of banks and mutual fund
organizations. These firms generally effect transactions at substantially lower
commission rates on an "execution only" basis, including through the Internet,
without offering other
13
services like investment and financial advice and research that are provided by
"full-service" brokerage firms such as us. Some of these 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 these firms
may adversely affect us.
In addition, some full-service brokerage firms have begun to provide
to customers discount services, including on-line trading over the Internet. In
response to the substantial recent growth in the availability of, and investor
demand for, on-line securities trading, we began to offer our clients the
ability to execute certain securities transactions on-line during fiscal year
2000. Our private client business may be adversely affected by the growing
demand for and availability of on-line securities trading, including our
provision of on-line trading services at competitive prices.
Certain institutions, notably commercial banks and thrift
institutions, have become a competitive factor in the financial services
industry by offering investment banking and corporate and individual financial
services traditionally provided only by securities firms. Commercial banks,
generally, are expanding their securities activities and their activities
relating to the provision of financial services, and are deriving more revenue
from these activities. In addition, in November 1999, legislation was passed
that effectively repealed certain laws that separated commercial banking,
investment banking and insurance activities. This legislation allows commercial
banks, securities firms and insurance firms to affiliate, which may accelerate
consolidation and lead to increasing competition in markets traditionally
dominated by investment banks and brokerage firms. 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 firms such as us that are heavily oriented to individual
investors.
Acquisitions
------------
As part of our business strategy, we review acquisitions in the
ordinary course and regularly engage in discussions with respect to potential
acquisitions, some of which may be material. Acquisitions involve a number of
risks and present financial, managerial and operational challenges, including:
. adverse effects on our reported earnings per share under current
accounting rules, which are expected to change, due to the
amortization of intangible assets associated with the acquisitions;
. existence of unknown liabilities; and
. potential disputes with the sellers.
An acquisition increases the risk that any business may lose customers or
employees, including key employees of the acquired business. An acquired
business could underperform relative to our expectations and we may not realize
the value we expect from the acquisition. Adverse market conditions or poor
investment or other performance by an acquired company may adversely affect
revenue and, in the case of an asset manager, its assets under management. We
could also experience financial or other setbacks if an acquired company has
problems of which we are not aware. Future acquisitions may further increase our
leverage or, if we issue equity securities to pay for the acquisitions, dilute
the holdings of our existing stockholders.
Regulation
----------
Our business is subject to regulation by various regulatory
authorities that are charged with protecting the interests of broker-dealers'
and investment advisers' customers. See "Regulation."
14
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 our
broker-dealer subsidiaries to expand or even maintain their present levels of
business. See "Net Capital Requirements."
Litigation
----------
Many aspects of our business involve substantial risks of liability.
In the normal course of business, our subsidiaries have been named as defendants
or co-defendants in lawsuits seeking substantial damages. We are also involved
from time to time in governmental and self-regulatory agency investigations and
proceedings. There has been an increased incidence of litigation in the
financial services industry in recent years, including customer claims as well
as class action suits seeking substantial damages. See "Item 3. Legal
Proceedings."
International Operations
------------------------
A number of our subsidiaries operate in Canada and the United Kingdom on
behalf of Canadian and UK clients. Our international operations require us to
comply with the legal requirements of foreign jurisdictions and expose us to the
political consequences of operating in foreign jurisdictions. Our foreign
business operations are also subject to the following risks:
. difficulty in managing, operating and marketing our international
operations;
. fluctuations in currency exchange rates which may result in
substantial negative effects on assets under management; and
. significant adverse changes in foreign legal and regulatory
environments.
Item 2. Properties.
- ------ ----------
The Company currently leases all of its office space. The Company's
headquarters, Baltimore sales office and other functions are located in an
office building in which the Company is the major tenant, currently occupying
approximately 370,000 square feet with annual base rent of approximately $7.8
million. The initial term of the lease will expire in 2009, with two renewal
options of eight years each.
During 2001, the Company's brokerage operations and technology
functions were relocated to a new office building in which the Company is the
sole tenant, currently occupying approximately 120,000 square feet with annual
base rent of approximately $1.9 million. The initial term of the lease will
expire in 2011, with three renewal options of five years each.
Information concerning the location of the Company's sales offices is
contained in Item 1 of this Report. See Note 8 of Notes to Consolidated
Financial Statements in Item 8 of this Report.
Item 3. Legal Proceedings.
- ------ -----------------
The Company's subsidiaries have been named as defendants or co-
defendants in various lawsuits alleging substantial damages and have been
involved in certain governmental and self-regulatory agency investigations and
proceedings. 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
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
15
be called upon to contribute to settlements or judgments. While the ultimate
resolution of pending litigation and other matters cannot be currently
determined, 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. However, if during any period a potential
adverse contingency should become probable, the results of operations in that
period could be materially affected.
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 2001 Annual Meeting of Stockholders) regarding certain executive
officers of the Company is as follows:
Peter L. Bain, age 42, was named head of the wealth managers
investment advisory group of the Company in June 2000. From 1995 to 2000, Mr.
Bain was a Managing Director of Berkshire Capital Corporation, a privately held
investment bank, and from 1997 to 2000 he was a member of the Management
Committee of that company. Mr. Bain is responsible for the strategic direction
of the Company's wealth managers investment advisory subsidiaries and for
ongoing acquisition strategy in the wealth managers market sector.
F. Barry Bilson, age 48, was elected Senior Vice President of the
Company in October 1998. Mr. Bilson was Vice President-Finance of the Company
from June 1984 through October 1998. Mr. Bilson has served in various financial
management capacities since joining the Company in 1981, and presently has
responsibility for business development projects and proprietary mutual fund
accounting. Mr. Bilson is a certified public accountant.
Charles J. Daley, Jr., age 39, became Vice President of the Company
in July 1999 and of Legg Mason Wood Walker in January 1999. He has served as
Controller of the Company and of Legg Mason Wood Walker since September 1997.
From September 1988 through September 1997, he served as Assistant Controller of
the Company and Legg Mason Wood Walker. Mr. Daley is a certified public
accountant.
Robert G. Donovan, age 56, was elected an Executive Vice President of
the Company in January 1998 and of Legg Mason Wood Walker in February 1998. He
became a Senior Vice President of Legg Mason Wood Walker in 1990. Mr. Donovan
has responsibility for the securities brokerage operations function of Legg
Mason Wood Walker.
Thomas P. Mulroy, age 40, was elected Senior Vice President of the
Company in July 2000 and an Executive Vice President of Legg Mason Wood Walker
in November 2000. He became a Senior Vice President of Legg Mason Wood Walker
in September 1998. From 1986 through 1998, Mr. Mulroy held various positions in
Legg Mason Wood Walker's capital markets operations. Mr. Mulroy has
responsibility for Legg Mason Wood Walker's equity research, institutional
equity sales and trading departments and New York Stock Exchange floor
operations.
Robert F. Price, age 53, became Secretary of the Company in July 2000
and of Legg Mason Wood Walker in November 2000, and has been Senior Vice
President and General Counsel of the Company and of Legg Mason Wood Walker since
November 1998. From September 1991 through August 1997, Mr. Price was Secretary
and General Counsel of Alex. Brown Incorporated. From September 1997 until
October 1998, Mr. Price was a Managing Director of BT Alex. Brown Incorporated,
a wholly owned subsidiary of Bankers Trust Corporation.
Robert G. Sabelhaus, age 53, became Senior Vice President of the
Company in July 2000 and Executive Vice President of Legg Mason Wood Walker in
August 1993. Mr. Sabelhaus is an executive officer in the private client
brokerage division of Legg Mason Wood Walker.
16
Timothy C. Scheve, age 43, became a Senior Executive Vice President of
the Company in July 2000 and of Legg Mason Wood Walker in November 2000. He had
been Executive Vice President of the Company and of Legg Mason Wood Walker since
January 1998 and was Treasurer of the Company from January 1992 to April 1999
and of Legg Mason Wood Walker from August 1992 to January 1999. Mr. Scheve has
served in various financial and administrative capacities since joining the
Company in 1984, and presently has primary responsibility for the Company's
administrative functions.
Thomas L. Souders, age 54, became Senior Vice President and Treasurer
of the Company in October 1999 and became Senior Vice President and Chief
Financial Officer of Legg Mason Wood Walker in September 1999. From August 1998
until September 1999, he was engaged in private investment activities. From
April 1986 until July 1998, he was the Chief Financial Officer of Wheat First
Butcher Singer, Inc., a financial services company. Mr. Souders is the Chief
Financial Officer of the Company.
Elisabeth N. Spector, age 53, 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.
Joseph A. Sullivan, age 43, became a Senior Vice President of the
Company in July 2000 and of Legg Mason Wood Walker in August 1994. He manages
Legg Mason Wood Walker's fixed income capital markets operations and has
responsibility for the oversight of the taxable and municipal fixed income
banking, trading, institutional sales, and research departments of Legg Mason
Wood Walker. He is a member of the Board of Directors of the Bond Market
Association.
Edward A. Taber, III, age 57, became a Senior Executive Vice President
of the Company in July 1995 and an Executive Vice President of the Company in
September 1992. He has overall responsibility for the Company's investment
management activities. Mr. Taber is a director or trustee of ten funds and
President of six funds within the Legg Mason mutual funds complex.
17
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, 2001, there were 2,331
holders 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
- -------------------------------------------------------------------------------
Fiscal 2001
Cash dividend per share/(1)/ $ .09 $ .09 $ .09 $ .08
Stock price range:
High 56.99 59.63 60.25 52.38
Low 40.15 42.88 47.63 35.13
Fiscal 2000
Cash dividend per share/(2)/ $ .08 $ .08 $ .08 $ .065
Stock price range:
High 51.25 41.75 40.94 42.88
Low 30.69 30.63 32.56 31.06
- -------------------------------------------------------------------------------
(1) Excluding $.16 per share declared by Perigee Inc. prior to being acquired
in the quarter ended June 30, 2000.
(2) Excluding $.60 per share declared by Perigee Inc. in fiscal 2000.
18
Item 6. Selected Financial Data/(1)/
- ------ ----------------------------
(Dollars in thousands except per share amounts)
Years ended March 31,
2001 2000 1999 1998 1997
- ----------------------------------------------------------------------------------------------------------------------------------
Operating Results
Total revenues $1,536,253 $1,399,585 $1,070,670 $ 909,306 $ 678,033
Interest expense 175,389 134,382 94,974 73,776 43,388
- ----------------------------------------------------------------------------------------------------------------------------------
Net revenues 1,360,864 1,265,203 975,696 835,530 634,645
Non-interest expenses 1,095,044 1,010,765 818,885 707,965 538,847
- ----------------------------------------------------------------------------------------------------------------------------------
Earnings before income tax provision 265,820 254,438 156,811 127,565 95,798
Income tax provision 109,590 104,025 63,537 52,258 39,020
- ----------------------------------------------------------------------------------------------------------------------------------
Net earnings $ 156,230 $ 150,413 $ 93,274 $ 75,307 $ 56,778
- ----------------------------------------------------------------------------------------------------------------------------------
Per Common Share/(2)/
Earnings per share:
Basic $ 2.45 $ 2.43 $ 1.57 $ 1.26 $ 1.01
Diluted 2.30 2.27 1.48 1.19 .93
Weighted average shares outstanding (in thousands):
Basic 63,793 61,868 59,516 59,611 56,318
Diluted 67,916 65,967 62,836 63,187 61,165
Dividends declared/(3)/ $ .350 $ .305 $ .250 $ .214 $ .191
Book value 14.14 12.09 9.51 8.48 7.37
- ----------------------------------------------------------------------------------------------------------------------------------
Financial Condition
Total assets $4,687,626 $4,812,107 $3,500,202 $2,856,389 $1,907,510
Senior notes 99,770 99,723 99,676 99,628 99,581
Notes payable of finance subsidiaries/(4)/ 119,200 239,268 -- -- --
Stockholders' equity 927,720 770,808 571,969 510,808 435,043
- ----------------------------------------------------------------------------------------------------------------------------------
/(1)/Restated to reflect all pooling of interests transactions.
/(2)/Adjusted to reflect all stock splits.
/(3)/Excluding $.16, $.60 and $.19 per share declared by Perigee Inc. prior to
acquisition in 2001, 2000 and 1999, respectively.
/(4)/Non-recourse, secured fixed-rate notes of LeggMason Investors finance
subsidiaries, the proceeds of which are invested in financial instruments
with similar maturities. See Notes 2 and 7 of Notes to Consolidated
Financial Statements.
19
Item 7. Management's Discussion and Analysis of
- ------ ---------------------------------------
Results of Operations and Financial Condition
- ---------------------------------------------
Business Description
Legg Mason, Inc. ("Parent") and its subsidiaries (collectively, the "Company")
are principally engaged in providing asset management, securities brokerage,
investment banking and related financial 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 securities prices, and the demand for investment banking
and mortgage banking services.
During fiscal 2001, U.S. equity markets were volatile and weakened from the
unprecedented strong market and economic conditions experienced during fiscal
2000. Despite weak U.S. and global markets, the Company achieved a sixth
consecutive year of record net revenues and net earnings, attributable to growth
in its asset management activities. Total assets under management for
institutions, Company-sponsored mutual funds and private accounts managed by the
Company's subsidiaries were $140 billion at March 31, 2001, up 25% from $112
billion a year earlier (excluding assets of approximately $14 billion managed by
Perigee Investment Counsel Inc. ("Perigee")). Revenues from asset management
activities tend to be more stable than those from private client and capital
markets activities because they are affected less by changes in securities
market conditions. Revenues from asset management activities, portions of which
are included in the asset management and private client segments, represented
48% of the Company's net revenues in fiscal 2001.
The Company's asset management activities and their contribution to operating
results have grown significantly through both internal growth and acquisition
over the past ten years. On February 5, 2001, the Company acquired an
approximate 70% interest in Barrett Associates, Inc. ("Barrett"), a high net
worth asset manager, in a transaction accounted for as a purchase. On May 26,
2000, the Company acquired Perigee, one of Canada's leading institutional
investment managers. This acquisition was accounted for as a pooling of
interests and, therefore, the financial statements have been restated as though
the acquisition had been completed at the beginning of each period presented.
During fiscal 2000, the Company acquired Berkshire Asset Management, Inc.
("Berkshire") and LeggMason Investors Holdings plc ("LeggMason Investors"),
formerly Johnson Fry Holdings PLC, and entered into a joint venture with Bingham
Dana LLP. At March 31, 2001, Berkshire managed assets of approximately $500
million, and LeggMason Investors managed assets of approximately $1.8 billion.
See Note 2 of Notes to Consolidated Financial Statements for additional
information regarding these acquisitions.
During fiscal 2001, net interest income continued to be a stable, growing
source of earnings, primarily as a result of substantial growth in retail
brokerage margin loan and customer credit balances and larger firm investment
balances. However, during the fourth fiscal quarter, net interest income
declined due to lower retail brokerage margin loan balances.
Results of any individual period should not be considered representative of
future profitability. Many of the Company's activities have fixed operating
costs that do not decline with reduced levels of business activity. 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 reductions.
Accordingly, sustained periods of unfavorable market conditions may affect
profitability adversely.
The Company operates within four business segments: Asset Management, Private
Client, Capital Markets and Other. Operations contained within each business
segment and each business segment's financial information for the last three
fiscal years are summarized below:
Asset Management
(in millions)
Years ended March 31,
-------------------------
2001 2000 1999
- ----------------------------------------------------------------------------
Net revenues.................................. $445.0 $376.7 $289.4
Pre-tax earnings.............................. 132.3 129.5 87.3
Asset Management provides investment advisory services to Company-sponsored
mutual funds and asset management for institutional and individual clients.
Private Client
(in millions)
Years ended March 31,
-------------------------
2001 2000 1999
- ----------------------------------------------------------------------------
Net revenues.................................. $707.4 $694.2 $523.8
Pre-tax earnings.............................. 113.3 114.2 70.7
Private Client distributes a wide range of financial products through its
branch distribution network, including equity and fixed income securities,
proprietary and non-affiliated mutual funds and annuities. Net interest profit
from customers' margin loan and credit account balances is included in this
business segment.
20
Capital Markets
(in millions)
Years ended March 31,
-------------------------
2001 2000 1999
- ----------------------------------------------------------------------------
Net revenues.................................. $174.3 $157.1 $126.8
Pre-tax earnings.............................. 15.5 5.0 8.5
Capital Markets consists of the Company's equity and fixed income
institutional sales and trading, syndicate, and corporate and public finance
activities. Sales credits associated with underwritten offerings are reported in
Private Client when sold through retail distribution channels and in Capital
Markets when sold through institutional distribution channels. This business
segment also includes realized and unrealized gains and losses on merchant
banking activities, private equity activities and warrants acquired in
connection with investment banking activities.
Other
(in millions)
Years ended March 31,
-------------------------
2001 2000 1999
- ----------------------------------------------------------------------------
Net revenues.................................. $34.2 $37.2 $35.7
Pre-tax earnings.............................. 4.7 5.7 (9.7)
Other consists principally of the Company's real estate service business. In
1999, pre-tax earnings included a non-cash deferred compensation expense of
$10.4 million related to a change in accounting treatment for a non-qualified
deferred compensation stock plan. See Note 13 of Notes to Consolidated Financial
Statements.
Results of Operations
The following table sets forth, for the periods indicated, items in the
Consolidated Statements of Earnings as percentages of net revenues and the
increase (decrease) by item as percentages of the amount for the previous
period:
Percentage of Net Revenues Period to Period Change
----------------------------------- -----------------------
Years ended March 31, 2001 2000
----------------------------------- Compared Compared
2001 2000 1999 to 2000 to 1999
- -------------------------------------------------------------------------------------------------------
Revenues
Investment advisory and related fees.... 48.1% 44.5% 42.5% 16.1% 35.9%
Commissions............................. 26.3 28.7 28.7 (1.2) 30.0
Principal transactions.................. 9.2 10.0 9.6 (1.4) 34.2
Investment banking...................... 4.8 5.5 7.8 (4.4) (9.5)
Interest................................ 20.7 17.6 16.4 26.5 39.0
Other................................... 3.8 4.3 4.7 (7.2) 19.3
Total revenues......................... 112.9 110.6 109.7 9.8 30.7
Interest expense........................ 12.9 10.6 9.7 30.5 41.5
Net revenues........................... 100.0 100.0 100.0 7.6 29.7
Non-Interest Expenses
Compensation and benefits............... 59.1 59.3 60.4 7.3 27.4
Communications and technology........... 7.6 7.0 7.5 16.3 19.9
Occupancy............................... 3.8 3.8 4.2 7.3 16.0
Floor brokerage and clearing fees....... 0.6 0.6 0.7 (1.5) 17.2
Non-cash deferred compensation.......... -- (0.1) 1.1 NM NM
Other................................... 9.4 9.3 10.0 9.3 20.1
Total non-interest expenses............ 80.5 79.9 83.9 8.3 23.4
Earnings Before Income Tax Provision..... 19.5 20.1 16.1 4.5 62.3
Income tax provision.................... 8.0 8.2 6.5 5.3 63.7
Net Earnings............................. 11.5% 11.9% 9.6% 3.9 61.3
- -------------------------------------------------------------------------------------------------------
NM-Not meaningful
21
Fiscal 2001 Compared with Fiscal 2000
In fiscal 2001, revenues, net earnings and earnings per share were higher than
in the prior fiscal year as the Company achieved record levels for the sixth
consecutive year. Net revenues increased 8% to $1.4 billion. Total revenues were
$1.5 billion, an increase of 10% from revenues of $1.4 billion in fiscal 2000.
Net earnings were $156.2 million, up 4% from net earnings in the prior fiscal
year. Basic earnings per share increased 1% to $2.45 from $2.43. Diluted
earnings per share increased 1% to $2.30 from $2.27.
Revenues
Investment Advisory and Related Fees
Investment advisory and related fees increased 16% to $654.0 million as a result
of growth in average assets under management in fixed income investment advisory
accounts, fee-based brokerage accounts and Company-sponsored mutual funds. In
addition, fiscal 2001 includes a full year of fees earned by LeggMason
Investors, acquired in December 1999.
Investment Advisory Revenues and
Assets Under Management
Investment Advisory
and Related Fee Assets Under
Revenues Management
(in millions, "M") (in billions, "B")
$654.0M $139.9B
$563.5M $111.8B
$414.7M $88.9B
$315.8M $71.0B
$221.6M $43.8B
Commissions
Commission revenues declined 1% to $358.6 million in fiscal 2001, primarily as a
result of a decrease in the volume of over-the-counter retail securities
transactions, partially offset by an increase in the volume of listed
institutional securities transactions and sales of non-proprietary mutual funds.
Principal Transactions
Revenues from principal transactions decreased 1% to $124.6 million, principally
as a result of lower equity trading profits.
Investment Banking
Investment banking revenues declined 4% to $65.9 million, primarily as a result
of a decline in fees from equity and municipal underwritings.
Interest Revenue and Expense
Interest revenue increased 27% to $282.2 million as a result of increases in
customer margin loan balances and firm investments, predominantly funds
segregated for regulatory purposes, and higher average interest rates.
Interest expense increased 31% to $175.4 million, primarily due to larger
interest-bearing customer credit balances and higher average interest rates.
The Company's net interest profit increased 21% to $106.8 million in fiscal
2001 from $88.6 million in fiscal 2000.
Other Revenues
Other revenues declined 7% to $51.1 million, primarily as a result of an
unrealized gain recognized in fiscal 2000 on warrants acquired in connection
with a private placement for a company which went public last year. In addition,
during fiscal 2001, the Company recorded unrealized losses on these warrants
reflecting a decline in market value. Both periods also include gains on the
sale of merchant banking investments.
Expenses
Compensation and Benefits
Compensation and benefits expense increased 7% to $804.8 million as a result of
higher fixed compensation costs, primarily attributable to an increase in the
number of employees, and higher incentive and sales compensation related to
asset management activities.
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 business
activity. Therefore, profitability may be affected adversely by sustained
periods of unfavorable market conditions or slow revenue growth in acquired
businesses or new product areas.
Communications and Technology
Communications and technology expense increased 16% to $102.8 million due to new
and expanded branch office locations, increased investments in technology, and
increased quote and telephone usage due to an increase in the number of
employees.
Occupancy
Occupancy costs increased 7% to $51.7 million as a result of additional costs
for new and expanded branch office locations and the impact of acquired
companies.
Floor Brokerage and Clearing Fees
Floor brokerage and clearing fees decreased 2% to $7.7 million, reflecting the
decline in securities transaction volume.
Other Expenses
Other expenses increased 9% to $128.1 million. This increase is primarily
attributable to the impact of a full year of expenses of LeggMason Investors,
increased promotional expenses, costs associated with the acquisition of Perigee
and increased intangible amortization expense related to acquired companies.
22
Income Tax Provision
The income tax provision rose 5% to $109.6 million in fiscal 2001 as a result of
increased pre-tax earnings and an increase in the Company's effective tax rate
to 41.2% in fiscal 2001 from 40.9% in the prior year. The increase in the
effective tax rate is primarily attributable to non-deductible foreign losses
and higher statutory tax rates in foreign jurisdictions.
Fiscal 2000 Compared with Fiscal 1999
In fiscal 2000, revenues, net earnings and earnings per share reached then-
record levels and were substantially higher than in the prior fiscal year. Net
revenues increased 30% to $1.3 billion. Total revenues were $1.4 billion, an
increase of 31% from revenues of $1.1 billion in fiscal 1999. Net earnings were
$150.4 million, up 61% from net earnings in the prior fiscal year. Basic
earnings per share increased 55% to $2.43 from $1.57. Diluted earnings per share
increased 53% to $2.27 from $1.48.
In accordance with Emerging Issues Task Force ("EITF") 97-14, results for
fiscal 2000 and fiscal 1999 include a non-cash deferred compensation credit of
$1.1 million and a non-cash expense of $10.4 million, respectively, related to a
change in accounting treatment for a non-qualified deferred compensation stock
plan and related compensation arrangements. See Note 13 of Notes to Consolidated
Financial Statements.
Revenues
Investment Advisory and Related Fees
Investment advisory and related fees increased 36% to $563.5 million as a result
of growth in assets under management in Company-sponsored mutual funds, fee-
based brokerage accounts and fixed income investment advisory accounts.
Commissions
Commission revenues rose 30% to $362.9 million in fiscal 2000, primarily as a
result of increases in listed and over-the-counter securities transactions and
increases in sales of non-affiliated mutual funds and annuity products.
Principal Transactions
Revenues from principal transactions increased 34% to $126.3 million,
principally as a result of increases in
sales and trading revenues from equity and fixed income securities.
Investment Banking
Investment banking revenues declined 9% to $68.9 million, primarily as a result
of a decline in corporate banking advisory fees.
Interest Revenue and Expense
Interest revenue increased 39% to $223.0 million as a result of increased firm
investments, predominantly funds segregated for regulatory purposes, customer
margin loan balances and stock borrow balances.
Interest expense increased 42% to $134.4 million, primarily due to larger
interest-bearing customer credit balances and stock loan balances.
As a result of significantly higher levels of stock borrow and stock loan
balances, the Company's net interest margin declined to 39.7% in fiscal 2000
from 40.8% in fiscal 1999.
The Company's net interest profit increased 35% to $88.6 million in fiscal
2000 from $65.5 million in fiscal 1999.
Other Revenues
Other revenues rose 19% to $55.0 million, primarily as a result of an unrealized
gain on warrants acquired in connection with a private placement for a company
which went public in the fourth quarter, a gain on the sale of a merchant
banking investment and revenue recorded from capitalizing mortgage servicing
assets on loans originated in fiscal 2000 as required by Statement of Financial
Accounting Standards ("SFAS") No. 125, "Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities."
Expenses
Compensation and Benefits
Compensation and benefits expense increased 27% to $750.2 million as a result of
higher sales and incentive compensation on increased revenues and profits and
higher fixed compensation costs, primarily attributable to an increase in the
number of employees.
Communications and Technology
Communications and technology expense increased 20% to $88.4 million due to
higher business volume, which gave rise to increased costs for trade processing,
quote services, printed materials, postage and telephone usage, and increased
investments in technology.
Occupancy
Occupancy costs increased 16% to $48.2 million as a result of increased costs of
acquired companies and additional and expanded branch office locations.
Floor Brokerage and Clearing Fees
Floor brokerage and clearing fees increased 17% to $7.8 million, reflecting
higher securities transaction volume.
Non-Cash Deferred Compensation
In fiscal 2000 and fiscal 1999, in accordance with EITF 97-14, the Company
recorded a non-cash deferred compensation credit of $1.1 million and a non-cash
deferred compensation charge of $10.4 million, respectively, related to a change
in accounting treatment for a non-qualified deferred compensation stock plan and
related compensation arrangements. See Note 13 of Notes to Consolidated
Financial Statements.
Other Expenses
Other expenses increased 20% to $117.2 million. This increase is primarily
attributable to the addition of expenses of LeggMason Investors, increased
intangible amortization expense related to acquired companies and higher loss,
error and litigation charges.
Income Tax Provision
The income tax provision rose 64% to $104.0 million in fiscal 2000 as a result
of increased pre-tax earnings. The Company's effective tax rate increased to
40.9% in fiscal 2000 compared with 40.5% in the prior year.
23
Liquidity and Capital Resources
The Company's total assets decreased to $4.7 billion at March 31, 2001 from $4.8
billion at March 31, 2000, primarily reflecting a decline in customer margin
account balances and securities borrowed. The Company's assets consist primarily
of cash and cash equivalents, collateralized short-term receivables and
securities. The collateralized receivables consist primarily of margin loans,
securities purchased under agreements to resell and securities borrowed, all of
which are secured by U.S. government and agency securities and corporate debt
and equity securities. During fiscal 2001, the Company shifted its exess cash to
institutional money market funds, which are included in cash equivalents, to
enhance yields. Previously, the Company's excess cash was invested in securities
purchased under agreements to resell. The highly liquid nature of the Company's
assets provides the Company with flexibility in financing and managing its
business.
For the year ended March 31, 2001, cash and cash equivalents increased $342.9
million. Cash flows from operating activities provided $223.6 million, primarily
attributable to net earnings, adjusted for non-cash charges. Investing
activities include the net payment of $16.6 million for the acquisition of
Barrett (see Note 2 of Notes to Consolidated Financial Statements), and $34.3
million in capital expenditures for enhancements in technology, relocation of
the Company's operations and technology center and additional branch offices
that opened in fiscal 2001. In addition, the decrease in securities purchased
under agreements to resell, as described above, provided $170.6 million of the
increase in cash and cash equivalents. Proceeds of $128.7 million, primarily
from maturity of a portion of investments held by the Company's finance
subsidiaries, were used to repay the related notes payable of $105.9 million
which became due in fiscal 2001.
The primary objective of the Company's capital structure and funding practices
is to appropriately support the Company's business strategies as well as the
regulatory capital requirements of its subsidiaries and provide needed liquidity
at all times.
The Company emphasizes diversification of funding sources and seeks to manage
exposure to refinancing risk. The Company's assets are funded by payables to
customers, securities loaned, bank loans, long-term debt and equity. The Company
obtains short-term financing primarily on a secured basis. The secured financing
is obtained through the use of securities lending agreements and secured bank
loans, which are primarily collateralized by U.S. government and agency
securities and corporate debt and equity securities. Short-term funding is
generally obtained at rates related to federal funds, LIBOR and money market
rates. The Company maintains uncommitted credit facilities from several banks
and financial institutions. Uncommitted facilities consist of credit lines that
the Company has been advised are available but for which no contractual lending
obligations exist.
During the quarter ended June 30, 2000, the Company arranged a new three-year,
committed, unsecured $100 million credit facility, which replaced a similar $50
million facility which expired in June. The facility has restrictive covenants
that require the Company, among other things, to maintain specified levels of
net worth and debt-to-equity ratios. The facility is available to be used by the
Company for general corporate purposes. There were no borrowings outstanding
under the current facility at March 31, 2001, or under the prior facility at
March 31, 2000.
The Company has outstanding $100 million of senior notes due February 15,
2006, which bear interest at 6.5%. The notes were originally issued at a
discount to yield 6.57%. At March 31, 2001, the Company had $500 million
available for the issuance of additional debt or convertible debt securities
pursuant to a shelf registration statement. A shelf filing permits a company to
register securities in advance and then sell them when financing needs arise or
market conditions are favorable. The Company intends to use the shelf for
general corporate purposes including the expansion of its business. As described
in Note 2 of Notes to Consolidated Financial Statements, the Company completed
the acquisition of Perigee, a Canadian money manager. Under the terms of the
agreement, the Company issued approximately 5.2 million exchangeable shares
which are the economic equivalent of, and have the same voting, dividend and
other rights as the Company's common shares.
The Company's broker-dealer subsidiaries are subject to the requirements of
the Securities and Exchange Commission's Uniform Net Capital Rule, which is
designed to measure the general financial soundness and liquidity of broker-
dealers. At March 31, 2001, the broker-dealer subsidiaries had aggregate net
capital of $291.4 million, which exceeded minimum net capital requirements by
$269.2 million. The amount of the broker-dealers' net assets that may be
distributed is subject to restrictions under applicable net capital rules.
The Company's overall capital and funding needs and capital base are
continually reviewed to support the estimated needs of its businesses. The
Company continues to explore potential acquisition opportunities as a means of
expanding its businesses. Such opportunities may involve acquisitions that are
material in size and may require the raising of additional capital.
On May 29, 2001, the Company entered into an agreement to acquire Private
Capital Management, L.P. ("PCM"), a privately owned, high net worth investment
management firm. At March 31, 2001, PCM managed assets of approximately $7.1
billion. Under the terms of the agreement, the Company will pay $682 million in
cash at closing, which is expected to occur during the second quarter of fiscal
2002. The transaction also includes two contingent payments based on PCM's
revenue growth as of the third and fifth anniversaries of closing, with the
aggregate purchase price to be no more than $1.382 billion. The acquisition will
be accounted for as a purchase.
Of the $682 million in cash required at closing, $150 million will be
available from the Company's excess cash and $250 million is being raised
through the private offering of zero coupon convertible notes, as described
below. The Company is currently assessing its financing options with respect to
the remainder of the purchase price.
On May 31, 2001, the Company entered into a purchase agreement for the sale of
$567 million principal amount at maturity of zero coupon convertible notes due
in 2031
24
resulting in gross proceeds of approximately $250 million (including an amount
covered by an exercised overallotment option). The convertible notes are being
offered to qualified institutional buyers at an initial offering price of
$440.70 per $1,000 principal amount at maturity. The issue price represents a
yield to maturity of 2.75% per annum, with an initial conversion premium of 25%
to the market value of the Company's common stock on the purchase date. Upon
certain events, each note is convertible into 7.7062 shares of the Company's
common stock, subject to adjustment. The Company may redeem the convertible
securities for cash on or after June 6, 2006 at their accreted value. In
addition, the Company may be required to repurchase the convertible securities
at their accreted value, at the option of the holders, on various dates
beginning on June 6, 2003. Such repurchases can be paid in cash, shares of the
Company's common stock or a combination of both.
Risk Management
Risk is an inherent part of the Company's business and activities. The extent to
which the Company properly and effectively identifies, assesses, monitors and
manages each of the various types of risk involved in its activities is critical
to its soundness and profitability. The Company seeks to identify, assess,
monitor and manage the following principal risks involved in the Company's
business activities: funding, market, credit, operational and legal.
Risk management at the Company is a multi-faceted process that requires
communication, judgment and knowledge of financial products and markets. The
Company's senior management takes an active role in the risk management process
and requires specific administrative and business functions to assist in the
identification, assessment and control of various risks. The Company's risk
management policies, procedures and methodologies are evolutionary in nature and
are subject to ongoing review and modification. Funding risk is discussed in the
"Liquidity and Capital Resources" section of "Management's Discussion and
Analysis of Results of Operations and Financial Condition."
Market Risk
The potential for changes in the value of the Company's financial instruments
owned is referred to as "market risk." The Company's market risk generally
represents the risk of loss that may result from a change in the value of a
financial instrument as a result of fluctuations in interest rates, credit
spreads, equity prices and the correlation among them, along with the level of
volatility. Interest rate risks result primarily from exposure to changes in the
yield curve, the volatility of interest rates, mortgage prepayments and credit
spreads. Equity price risks result from exposure to changes in prices and
volatilities of individual equities, equity baskets and equity indices.
The Company makes dealer markets in equity and debt securities. As such, to
facilitate customer order flow, the Company may be required to own equity and
debt securities in its trading and inventory accounts. The Company hedges its
exposure to market risk by managing its net long or short position. For example,
the Company may hedge a municipal portfolio by taking an offsetting position in
a related futures contract. Position limits in trading and inventory accounts
are established and monitored on an ongoing basis. Each day, consolidated
position and exposure reports are prepared and distributed to various levels of
Company management, which enable management to monitor inventory levels and
results of the trading groups. The Company also monitors inventory aging,
pricing, concentration and securities ratings.
In accordance with the Securities and Exchange Commission's risk disclosure
requirements, the following table categorizes the Company's market risk
sensitive financial instruments:
Financial Instruments with Market Risk at March 31, 2001
Years to Maturity
----------------------------------------------------------
1 or less 1 to 5 5 to 10 Over 10 Total
- ------------------------------------------------------------------------------------------------------------------------
Fair Value
U.S. government and agencies............................. $ 65,061 $(23,928) $ 358 $ 4,861 $ 46,352
Corporate debt........................................... 3,698 10,939 7,184 15,158 36,979
State and municipal bonds................................ 755 8,901 22,670 40,226 72,552
- ------------------------------------------------------------------------------------------------------------------------
Total debt securities................................... 69,514 (4,088) 30,212 60,245 155,883
Equity & other securities................................ -- -- -- 10,892 10,892
- ------------------------------------------------------------------------------------------------------------------------
Total................................................... $ 69,514 $ (4,088) $30,212 $71,137 $166,775
========================================================================================================================
Weighted Average Yield
U.S. government and agencies............................. 5.29% 5.27% 5.03% 6.03%
Corporate debt........................................... 5.43 6.86 6.39 7.76
State and municipal bonds................................ 4.61 4.09 4.07 4.53
- ------------------------------------------------------------------------------------------------------------------------
25
Financial Instruments with Market Risk at March 31, 2000
Years to Maturity
----------------------------------------------------------
1 or less 1 to 5 5 to 10 Over 10 Total
- ------------------------------------------------------------------------------------------------------------------------
Fair Value
U.S. government and agencies............................. $ 94,859 $ (5,364) $(4,649) $ 6,617 $ 91,463
Corporate debt........................................... 1,888 3,111 8,454 2,481 15,934
State and municipal bonds................................ 17,880 9,847 6,745 20,912 55,384
- ------------------------------------------------------------------------------------------------------------------------
Total debt securities................................... 114,627 7,594 10,550 30,010 162,781
Equity & other securities................................ -- -- -- 20,482 20,482
- ------------------------------------------------------------------------------------------------------------------------
Total................................................... $114,627 $ 7,594 $10,550 $50,492 $183,263
========================================================================================================================
Weighted Average Yield
U.S. government and agencies............................. 5.34% 5.41% 6.25% 7.05%
Corporate debt........................................... 5.93 6.85 7.08 7.79
State and municipal bonds................................ 4.62 4.61 4.92 5.15
- ------------------------------------------------------------------------------------------------------------------------
The tables primarily represent trading inventory associated with our customer
facilitation and market-making activities, and include net long and short fair
values, which is consistent with the way risk exposure is managed. See Notes 4
and 5 of Notes to Consolidated Financial Statements for the related gross long
and short fair values of financial instruments owned and investments. The
tables also include treasury securities segregated for regulatory purposes of
$64.4 million and $90.3 million at March 31, 2001 and 2000, respectively.
The purpose of the LeggMason Investors finance subsidiaries (see Note 2 of
Notes to Consolidated Financial Statements) is to raise funds by issuing secured
fixed-rate loan securities and to use the proceeds to invest in a portfolio of
bonds issued by various financial institutions which are not generally available
to the public in tranches small enough for the retail investor. The Investments
of finance subsidiaries and the Notes payable of finance subsidiaries are
directly related and have offsetting risk characteristics and do not represent a
material market risk to the Company. Additionally, claims of the note holders
are limited to the assets of the finance subsidiaries, which limits the
Company's exposure to default risk on the investments.
In addition to the financial instruments included in the table, the Company
has $100 million senior notes payable that mature in 2006 and bear a fixed
coupon of 6.5%. The notes were issued at a discount to yield 6.57%.
The Company's net investments in foreign subsidiaries are impacted by
fluctuations of foreign exchange rates. These fluctuations are recorded as a
component of Stockholders' equity and are not material to the Company's
financial condition. The impact of currency fluctuations on the Company's
results of operations is not material.
Credit Risk
Credit risk represents the loss that the Company would incur if a counterparty
or issuer of securities or other instruments held by the Company fails to
perform its contractual obligations to the Company. Credit risk related to
various investing and financing activities is reduced by the industry practice
of obtaining and maintaining collateral.
Credit exposure associated with the Company's private client business consists
primarily of customer margin accounts, which are monitored daily. The Company
monitors exposure to industry sectors and individual securities and performs
sensitivity analysis on a regular basis in connection with its margin lending
activities. The Company adjusts its margin requirements if it believes its risk
exposure is not appropriate based on market conditions.
Operational Risk
Operational risk generally refers to the risk of loss resulting from the
Company's operations, including, but not limited to, improper or unauthorized
execution and processing of transactions, deficiencies in the Company's
operating systems and inadequacies or breaches in the Company's control process.
The Company operates different businesses in diverse markets and is reliant on
the ability of its employees and systems to process high numbers of
transactions. In the event of a breakdown or improper operation of systems or
improper action by employees, the Company could suffer financial loss,
regulatory sanctions and damage to its reputation. In order to mitigate and
control operational risk, the Company has developed and continues to enhance
specific policies and procedures that are designed to identify and manage
operational risk at appropriate levels. For example, the Company has procedures
that require that all transactions are accurately recorded and properly
reflected in the Company's books and records and are confirmed on a timely
basis; that position valuations are subject to periodic independent review
procedures and that collateral and adequate documentation are obtained from
counterparties in appropriate circumstances. Disaster recovery plans exist for
critical systems, and redundancies are built into the systems as deemed
appropriate. The Company also uses periodic self-assessments and internal audit
reviews as a further check on operational risk.
26
Legal Risk
Legal risk includes the risk of non-compliance with applicable legal and
regulatory requirements. The Company is generally subject to extensive
regulation in the different jurisdictions in which it conducts its business. The
Company has various procedures addressing issues, such as regulatory capital
requirements, sales and trading practices, use of and safekeeping of customer
funds, credit granting, collection activities, money-laundering and record
keeping.
Effects of Inflation
The Company's assets are not significantly affected by inflation because they
are primarily monetary, consisting of cash and cash equivalents, securities and
receivables. However, the rate of inflation affects various expenses, including
employee compensation, communications and technology, and occupancy, which may
not be readily recoverable in charges for services provided by the Company.
Recent Accounting Developments
Effective April 1, 2001, the Company adopted the provisions of SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133
requires the Company to report derivative instruments as assets or liabilities
on the balance sheet and to measure those instruments at fair value. Generally,
the Company does not engage in derivative or hedging activities, except for
limited trading-related activities at the Company's primary broker-dealer
subsidiary. Since such derivatives are accounted for on a mark-to-market basis
through earnings, the adoption of Statement No. 133 did not impact the Company's
financial statements.
In September 2000, the Financial Accounting Standards Board ("FASB") released
SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities - a replacement of FASB No. 125." For fiscal year
2001, the Company has adopted the provisions of SFAS No. 140 that require the
Company to classify financial assets owned and pledged as collateral, if the
secured party has the right to sell or repledge the collateral. (See Notes 4 and
14 of Notes to Consolidated Financial Statements.) Adoption of these provisions
of SFAS No. 140 did not have a material impact on the Company's financial
statements. Other provisions of SFAS No. 140 are not required to be adopted
until after March 31, 2001. These provisions provide guidance for distinguishing
whether a transfer of assets should be accounted for as a sale or a secured
borrowing. The impact of adopting the provisions of SFAS No. 140 that became
effective after March 31, 2001 is not material to the Company's financial
statements.
In February 2001, the FASB released a proposed accounting standard that, if
adopted, would change the accounting for goodwill. If the standard is adopted,
goodwill would no longer be amortized. Since goodwill represented approximately
65% of the unamortized intangible asset balance at March 31, 2001, under similar
circumstances in the future, the Company's net income and earnings per share may
be higher for this reason. There can be no assurance that this standard will be
adopted in its proposed form, or at all.
Forward-Looking Statements
Information or statements provided by or on behalf of the Company from time to
time, including those within this Report, may contain certain "forward-looking
information," including information relating to anticipated growth in revenues
or earnings per share, anticipated changes in its businesses or in the amount of
client assets under management, anticipated expense levels and expectations
regarding financial market conditions. The Company cautions readers that any
forward-looking information provided by or on behalf of the Company is not a
guarantee of future performance. Actual results may differ materially from those
in forward-looking information as a result of various factors, including but not
limited to those discussed below and elsewhere in this Report. Further, such
forward-looking statements speak only as of the date on which such statements
are made, and the Company undertakes no obligations to update any forward-
looking statement to reflect events or circumstances after the date on which
such statement is made or to reflect the occurrence of unanticipated events.
The Company's future revenues may fluctuate due to numerous factors, such as:
the volume of trading in securities; the volatility and general level of market
prices; the total value and composition of assets under management; the relative
investment performance of Company-sponsored mutual funds compared with competing
offerings and market indices; sentiment and investor confidence; the ability of
the Company to maintain investment management and administrative fees at current
levels; competitive conditions in each of the Company's business segments; the
demand for investment banking and mortgage banking services; and the effects of
acquisitions.
The Company's future operating results are also dependent upon the level of
operating expenses, which are subject to fluctuation for the following or other
reasons: variations in the level of compensation expense incurred by the Company
as a result of changes in the number of total employees, competitive factors, or
other reasons; variations in expenses and capital costs, including depreciation,
amortization and other non-cash charges incurred by the Company to maintain its
administrative infrastructure; unanticipated costs that may be incurred by the
Company from time to time to protect client goodwill or in connection with
litigation; and the effects of acquisitions.
The Company's business is also subject to substantial governmental regulation,
and changes in legal, regulatory, accounting, tax and compliance requirements
may have a substantial effect on the Company's business and results of
operations.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
- ------- ----------------------------------------------------------
See "Item 7. Management's Discussion and Analysis of Results of
Operations and Financial Condition - Liquidity and Capital Resources - Risk
Management" for disclosure about market risk.
27
Item 8. Financial Statements and Supplementary Data
- ---- -------------------------------------------
To the Board of Directors
and Stockholders of Legg Mason, Inc.
In our opinion, the accompanying consolidated statements of financial condition
of Legg Mason, Inc. and Subsidiaries (the "Company") and the related
consolidated statements of earnings, changes in stockholders' equity,
comprehensive income and cash flows present fairly, in all material respects,
the consolidated financial position of Legg Mason, Inc. and Subsidiaries at
March 31, 2001 and 2000, and the consolidated results of their operations and
their cash flows for each of the three years in the period ended March 31, 2001,
in conformity with accounting principles generally accepted in the United States
of America. 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 of these financial
statements in accordance with auditing standards generally accepted in the
United States of America which 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, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
/s/ PriceWaterhouseCoopers LLP
Baltimore, Maryland
May 3, 2001, except for
Note 17, as to which
the date is May 31, 2001
28
CONSOLIDATED STATEMENTS OF EARNINGS
(Dollars in thousands except per share amounts)
Years ended March 31,
2001 2000 1999
- ---------------------------------------------------------------------------------
Revenues
Investment advisory and related fees $ 653,992 $ 563,463 $ 414,732
Commissions 358,562 362,887 279,136
Principal transactions 124,556 126,267 94,105
Investment banking 65,877 68,905 76,118
Interest 282,201 223,030 160,433
Other 51,065 55,033 46,146
- ---------------------------------------------------------------------------------
Total revenues 1,536,253 1,399,585 1,070,670
Interest expense 175,389 134,382 94,974
- ---------------------------------------------------------------------------------
Net revenues 1,360,864 1,265,203 975,696
- ---------------------------------------------------------------------------------
Non-Interest Expenses
Compensation and benefits 804,776 750,210 588,986
Communications and technology 102,764 88,375 73,723
Occupancy 51,670 48,175 41,535
Floor brokerage and clearing fees 7,709 7,828 6,677
Non-cash deferred compensation -- (1,063) 10,352
Other 128,125 117,240 97,612
- ---------------------------------------------------------------------------------
Total non-interest expenses 1,095,044 1,010,765 818,885
- ---------------------------------------------------------------------------------
Earnings Before Income Tax Provision 265,820 254,438 156,811
Income tax provision 109,590 104,025 63,537
- ---------------------------------------------------------------------------------
Net Earnings $ 156,230 $ 150,413 $ 93,274
=================================================================================
Earnings per Common Share
Basic $2.45 $2.43 $1.57
Diluted 2.30 2.27 1.48
=================================================================================
See notes to consolidated financial statements.
29
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in thousands)
March 31,
2001 2000
- -----------------------------------------------------------------------------------
Assets
Cash and cash equivalents $ 556,148 $ 213,203
Cash and securities segregated for regulatory
purposes 1,942,110 1,419,021
Securities purchased under agreements
to resell -- 170,643
Receivables:
Customers 1,102,920 1,386,676
Brokers, dealers and clearing
organizations 108,560 163,263
Others 121,600 110,157
Securities borrowed 247,229 671,252
Financial instruments owned, at fair
value 127,188 102,907
Investment securities, at fair value 14,050 17,765
Investments of finance subsidiaries 115,226 241,639
Equipment and leasehold improvements,
net 71,645 61,243
Intangible assets, net 149,449 145,142
Other 131,501 109,196
- -----------------------------------------------------------------------------------
$4,687,626 $4,812,107
===================================================================================
Liabilities and Stockholders' Equity
Liabilities
Payables:
Customers $2,909,147 $2,633,542
Brokers and dealers 45,787 14,333
Securities loaned 252,925 688,331
Short-term borrowings 4,900 23,290
Financial instruments sold, but not yet purchased,
at fair value 38,814 27,713
Accrued compensation 146,279 147,188
Other 143,084 167,911
Notes payable of finance subsidiaries 119,200 239,268
Senior notes 99,770 99,723
- -----------------------------------------------------------------------------------
3,759,906 4,041,299
- -----------------------------------------------------------------------------------
Commitments and Contingencies (Note 8)
- -----------------------------------------------------------------------------------
Stockholders' Equity
Common stock, par value $.10;
authorized 250,000,000 shares;
issued 62,849,994 shares in 2001 and 58,599,058
shares in 2000 6,285 5,860
Shares exchangeable into common stock 10,439 19,527
Additional paid-in capital 330,394 271,687
Deferred compensation and employee note receivable (36,406) (19,003)
Employee stock trust (81,225) (50,699)
Deferred compensation employee stock
trust 81,225 50,699
Retained earnings 624,665 493,696
Accumulated other comprehensive loss,
net (7,657) (959)
- -----------------------------------------------------------------------------------
927,720 770,808
- -----------------------------------------------------------------------------------
$4,687,626 $4,812,107
===================================================================================
See notes to consolidated financial statements.
30
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Dollars in thousands)
Years ended March 31,
2001 2000 1999
- -------------------------------------------------------------------
Common Stock
Beginning balance $ 5,860 $ 5,638 $ 2,753
Shares issued for:
Stock option exercises 115 130 70
Deferred compensation trust 19 21 11
Deferred compensation 50 71 23
Exchangeable shares 241 -- --
2-for-1 stock split -- -- 2,781
- -------------------------------------------------------------------
Ending balance 6,285 5,860 5,638
- -------------------------------------------------------------------
Shares Exchangeable into Common Stock
Beginning balance 19,527 19,527 12,426
Adjustment for business
combination -- -- 7,101
Exchanges (9,088) -- --
- -------------------------------------------------------------------
Ending balance 10,439 19,527 19,527
- -------------------------------------------------------------------
Additional Paid-In Capital
Beginning balance 271,687 215,387 203,133
Stock option exercises 17,073 17,440 3,368
Deferred compensation trust 9,128 13,411 5,131
Deferred compensation 23,659 25,449 6,536
Exchangeable shares 8,847 -- --
2-for-1 stock split -- -- (2,781)
- -------------------------------------------------------------------
Ending balance 330,394 271,687 215,387
- -------------------------------------------------------------------
Deferred Compensation and Employee Note Receivable
Beginning balance (19,003) (5,362) --
Increase in unearned
compensation (22,820) (14,342) (5,362)
- -------------------------------------------------------------------
Amortization of deferred
compensation 5,417 701 --
- -------------------------------------------------------------------
Ending balance (36,406) (19,003) (5,362)
- -------------------------------------------------------------------
Employee Stock Trust
Beginning balance (50,699) (18,475) --
Shares issued to employee
stock trust, net (30,526) (32,224) (18,475)
- -------------------------------------------------------------------
Ending balance (81,225) (50,699) (18,475)
- -------------------------------------------------------------------
Deferred Compensation Employee Stock Trust
Beginning balance 50,699 (11,470) --
Net increase in deferred
compensation 30,526 62,169 (11,470)
- -------------------------------------------------------------------
Ending balance 81,225 50,699 (11,470)
- -------------------------------------------------------------------
Retained Earnings
Beginning balance 493,696 368,804 292,035
Dividends declared (24,817) (25,521) (16,505)
Adjustment to conform fiscal
year of pooled entity (444) -- --
Net earnings 156,230 150,413 93,274
- -------------------------------------------------------------------
Ending balance 624,665 493,696 368,804
- -------------------------------------------------------------------
Accumulated Other Comprehensive Income (Loss), net
Beginning balance (959) (2,080) 461
Unrealized holding gains
(losses) on investment
securities, net/(1)/ 2,995 714 (1,119)
Reclassification adjustment
for (gains) losses
included in net income (582) 42 --
Foreign currency
translation adjustment (9,111) 365 (1,422)
- -------------------------------------------------------------------
Ending balance (7,657) (959) (2,080)
- -------------------------------------------------------------------
Total Stockholders' Equity $927,720 $770,808 $571,969
===================================================================
/(1)/Net of deferred income taxes of ($235) in 2001, ($152) in 2000 and $671 in
1999.
See notes to consolidated financial statements.
31
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in thousands)
Years ended March 31,
2001 2000 1999
- ---------------------------------------------------------------------------------------------
Net Earnings $156,230 $150,413 $93,274
Other comprehensive income (loss):
Foreign currency translation adjustment (9,111) 365 (1,422)
- ---------------------------------------------------------------------------------------------
Unrealized gains (losses) on investment securities:
Unrealized holding gains (losses) arising
during the period 3,230 866 (1,790)
Reclassification adjustment for (gains) losses
included in net income (582) 42 --
- ---------------------------------------------------------------------------------------------
Net unrealized gains (losses) 2,648 908 (1,790)
Deferred income taxes (235) (152) 671
- ---------------------------------------------------------------------------------------------
Total other comprehensive income (loss) (6,698) 1,121 (2,541)
- ---------------------------------------------------------------------------------------------
Comprehensive Income $149,532 $151,534 $90,733
=============================================================================================
See notes to consolidated financial statements.
32
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Years ended March 31,
2001 2000 1999
- ----------------------------------------------------------------------------------------------------------------------
Cash Flows from Operating Activities:
Net earnings $ 156,230 $ 150,413 $ 93,274
Non-cash items included in earnings:
Depreciation and amortization 36,495 30,821 22,675
Originated mortgage servicing rights (1,827) (2,685) --
Deferred compensation 5,417 6,131 17,812
Deferred income taxes (4,959) (5,207) (6,296)
Decrease (increase) in assets excluding acquisitions:
Cash and securities segregated for regulatory purposes (523,089) (44,766) (452,649)
Receivables from customers 283,756 (500,174) (205,667)
Other receivables 41,250 (79,518) (68,956)
Securities borrowed 424,023 (362,533) 139,734
Financial instruments owned (24,281) 41,091 (62,541)
Other (29,845) 4,585 (23,996)
Increase (decrease) in liabilities excluding acquisitions:
Payable to customers 275,605 462,954 607,591
Payable to brokers and dealers 31,454 4,815 5,146
Securities loaned (435,406) 376,513 (141,212)
Financial instruments sold, but not yet purchased 11,101 15,891 (2,310)
Accrued compensation (1,951) 34,630 12,788
Deferred compensation trust -- -- 1,028
Other (20,324) 36,505 3,738
- ----------------------------------------------------------------------------------------------------------------------
Cash Provided by (Used for) Operating Activities 223,649 169,466 (59,841)
- ----------------------------------------------------------------------------------------------------------------------
Cash Flows from Investing Activities:
Payments for:
Equipment and leasehold improvements (34,311) (23,297) (19,456)
Management contracts and mortgage servicing portfolios (3,818) (95) (655)
Acquisitions, net of cash acquired (16,601) (87,637) --
Proceeds from sale of assets 2,417 -- --
Net (increase) decrease in securities purchased under agreements to resell 170,643 (29,627) 34,607
Purchases of investment securities (13,151) (52,384) (36,677)
Proceeds from sales and maturities of investment securities 128,697 54,104 51,395
- ----------------------------------------------------------------------------------------------------------------------
Cash Provided by (Used for) Investing Activities 233,876 (138,936) 29,214
- ----------------------------------------------------------------------------------------------------------------------
Cash Flows from Financing Activities:
Net increase (decrease) in short-term borrowings (18,390) (25,972) 35,382
Repayment of notes payable of finance subsidiaries (105,909) (678) --
Issuance of common stock 21,037 20,780 10,995
Dividends paid (23,615) (24,509) (15,860)
- ----------------------------------------------------------------------------------------------------------------------
Cash Provided by (Used for) Financing Activities (126,877) (30,379) 30,517
- ----------------------------------------------------------------------------------------------------------------------
Effect of Exchange Rate Changes on Cash 12,297 327 (229)
Net Increase (Decrease) in Cash and Cash Equivalents 342,945 478 (339)
Cash and Cash Equivalents at Beginning of Year 213,203 212,725 213,064
- ----------------------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents at End of Year $ 556,148 $ 213,203 $ 212,725
======================================================================================================================
Supplementary Disclosure
Cash paid for:
Income taxes $ 98,804 $ 97,280 $ 70,487
Interest 176,460 127,224 94,673
See notes to consolidated financial statements.
33
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 subsidiaries (collectively, the "Company")
are principally engaged in providing asset management, securities brokerage,
investment banking and related financial services to individuals, institutions,
corporations and municipalities.
The consolidated financial statements include the accounts of the Parent and
its subsidiaries. All material intercompany balances and transactions have been
eliminated. The consolidated financial statements have been restated to reflect
the business combination (as described in Note 2) of Perigee Investment Counsel
Inc. ("Perigee") accounted for as a pooling of interests. Unless otherwise
noted, all per share amounts include both common shares of the Company and
shares issued in connection with the Perigee acquisition, which are exchangeable
into common shares of the Company on a one-for-one basis at any time. Where
appropriate, prior years' financial statements have been reclassified to conform
to the current year presentation.
The consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States, which require
management to make assumptions and estimates that affect the amounts reported in
the financial statements and accompanying notes. Actual amounts could differ
from those estimates.
Cash and Cash Equivalents
Cash equivalents are highly liquid investments with original maturities of 90
days or less, other than those held for sale in the ordinary course of business.
Securities Purchased Under Agreements to Resell
The Company invests in short-term securities purchased under agreements to
resell collateralized by U.S. government and agency securities. Securities
purchased under agreements to resell are accounted for as collateralized
financings. It is the policy of the Company to obtain possession of collateral
with a market value in excess of the principal amount loaned. Collateral is
valued daily, and the Company may require counterparties to deposit additional
collateral when appropriate. Securities purchased under agreements to resell are
carried at the amounts at which the securities will be subsequently resold, as
specified in the respective agreements, plus accrued interest.
Securities Transactions
Customer securities transactions are recorded on a settlement date basis, with
related commission revenues and expenses recorded on a trade date basis.
Financial Instruments Owned
Financial instruments used in the Company's trading activities are recorded on a
trade date basis and carried at fair value with unrealized gains and losses
reflected in earnings. The fair values are generally based on listed market
prices or dealer price quotations for similar instruments. The Company carries
its private equity investments at fair value based upon the Company's assessment
of the underlying investments.
Securities Lending
Securities borrowed and loaned are accounted for as collateralized financings
and recorded at the amount of collateral advanced or received. Securities
borrowed transactions require the Company to deposit cash or other collateral
with the lender. The Company generally receives collateral in the form of cash
for securities loaned. The fee received or paid by the Company is recorded as
interest revenue or expense. The Company monitors the fair value of securities
borrowed and loaned on a daily basis, with additional collateral obtained or
refunded, as necessary.
Investments
The Company holds debt and equity investments which are generally classified as
available-for-sale and held-to-maturity. Debt and equity securities classified
as available-for-sale are reported at fair value and resulting unrealized gains
and losses are reflected in stockholders' equity and comprehensive income.
Debt securities held by the Company's finance subsidiaries, for which there is
positive intent and ability to hold to maturity, are classified as held-to-
maturity. These investments are recorded at amortized cost and amortization of
discount or premium is included in current period earnings.
Depreciation and Amortization
Equipment and leasehold improvements are reported at cost, net of accumulated
depreciation and amortization of $71,895 and $67,151 at March 31, 2001 and 2000,
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.
34
Intangible Assets
Intangible assets consist principally of goodwill and asset management and
mortgage servicing contracts and are reported at cost net of accumulated
amortization. The Company capitalizes costs incurred in acquiring mortgage
servicing rights through loan origination activities in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities."
Intangibles are amortized using straight-line methods principally over periods
not exceeding twenty years. Accumulated amortization at March 31, 2001 and 2000
was $43,708 and $52,005, 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
that the amortization periods are appropriate.
Fair Value of Financial Instruments
At March 31, 2001 and 2000, substantially all financial instruments are carried
at fair value or amounts which approximate fair value. The fair values of the
senior notes, estimated using current market prices, were $97,480 and $93,150 at
March 31, 2001 and 2000, respectively.
Translation of Foreign Currencies
Assets and liabilities of foreign subsidiaries that are denominated in non-U.S.
dollar functional currencies are translated at exchange rates at the statement
of financial condition date. Revenues and expenses are translated at average
exchange rates during the period. The gains or losses resulting from translating
foreign currency financial statements into U.S. dollars are included in
stockholders' equity and comprehensive income. Gains or losses resulting from
foreign currency transactions are included in earnings.
Investment Advisory and Related Fees
The Company earns investment advisory fees on assets in accounts managed by its
subsidiaries, distribution fees on assets in Company-sponsored mutual funds and
asset-based fees on various types of single-fee brokerage accounts. In addition,
the Company earns fees for performing certain administrative services for its
funds. Revenues from investment advisory and related activities are recognized
over the period in which services are performed. Performance fees are recognized
at the end of the performance period.
Stock-Based Compensation
The Company accounts for stock-based compensation in accordance with Accounting
Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to
Employees" as permitted by SFAS No. 123, "Accounting for Stock-Based
Compensation." The Company's stock-based compensation plans include stock
options, restricted awards, stock purchase plans and deferred compensation
payable in stock.
In accordance with APB No. 25, compensation expense is not recognized for stock
options that have no intrinsic value on the date of grant. The pro forma effects
of SFAS No. 123 on net income and earnings per share are presented in Note 12.
Earnings Per Share
Earnings per share ("EPS") is calculated by dividing net earnings by the
weighted average number of common shares outstanding. Diluted EPS is similar to
basic EPS, but adjusts for the effect of potential common shares.
The following table presents the computations of basic and diluted EPS:
Years ended March 31,
(shares in thousands) 2001 2000 1999
- --------------------------------------------------------------
Weighted average common
shares outstanding........... 63,793 61,868 59,516
Potential common shares:
Employee stock options....... 3,622 3,794 3,272
Shares related to
deferred compensation....... 501 257 --
Shares issuable upon
conversion of
debentures.................. -- 48 48
- --------------------------------------------------------------
Total weighted average
diluted common shares........ 67,916 65,967 62,836
- --------------------------------------------------------------
Net earnings.................. $156,230 $150,413 $93,274
Adjustment related to
deferred compensation,
net of tax................... -- (638) --
Interest expense on
convertible debentures,
net of tax................... -- 18 18
- --------------------------------------------------------------
Net earnings applicable to
diluted common shares........ $156,230 $149,793 $93,292
- --------------------------------------------------------------
Basic EPS..................... $ 2.45 $ 2.43 $ 1.57
Diluted EPS................... 2.30 2.27 1.48
- --------------------------------------------------------------
At March 31, 2001 and 2000, options to purchase 1,897,850 and 57,000 shares,
respectively, were not included in the computation of diluted earnings per share
because the options' exercise prices were greater than the average price of the
common shares for the period. In addition, at March 31, 2001, 2000 and 1999,
633,967, 69,405 and 1,423,619 shares, respectively, held in an employee stock
trust were antidilutive and therefore excluded from the computation of diluted
earnings per share.
35
2. Business Combinations
On February 5, 2001, the Company acquired an approximate 70% ownership interest
in Barrett Associates, Inc. ("Barrett"), a high net worth asset manager for
individuals, families, endowments and foundations. The Company acquired this
controlling interest for approximately $18,500. Under the terms of the
acquisition agreement, the remaining 30% interest will be acquired over the next
five years for an additional amount up to $22,500 based on Barrett's revenues in
the second and fifth years. The acquisition was accounted for as a purchase and,
accordingly, the net assets and results of operations are included in the
Company's consolidated financial statements from the date of acquisition. The
excess of the purchase price over the interest in the net assets acquired of
approximately $17,000 is being amortized on a straight-line basis over periods
up to 15 years. The ownership interest not owned by the Company is recorded as
minority interest and is not material.
On May 26, 2000, the Company completed the acquisition of Perigee, one of
Canada's leading institutional investment managers. In April 2001, Perigee Inc.
was merged into its operating subsidiary, Perigee Investment Counsel Inc. Under
the terms of the acquisition agreement, each outstanding share of Perigee was
exchanged for 0.387 of an exchangeable share of Legg Mason Canada Holdings, a
subsidiary of the Company. Holders of exchangeable shares have dividend, voting,
and other rights equivalent to those of common stockholders. These exchangeable
shares are the economic equivalent of common shares of the Company and may be
exchanged for those shares on a one-for-one basis at any time. The Company
issued approximately 5.2 million exchangeable shares in this transaction. The
acquisition was accounted for as a pooling of interests and, accordingly, all
prior period consolidated financial statements have been restated to include the
combined results of operations, financial position and cash flows of Perigee.
Net revenues and net income of the Company and Perigee for the years ended
March 31, 2000 and 1999 were as follows:
Years ended March 31,
2000 1999
- --------------------------------------------------
Net revenues
As previously reported... $1,236,482 $951,096
Perigee.................. 28,721 24,600
- --------------------------------------------------
Combined.................. $1,265,203 $975,696
- --------------------------------------------------
Net earnings
As previously reported... $ 142,525 $ 89,334
Perigee.................. 7,888 3,940
- --------------------------------------------------
Combined.................. $ 150,413 $ 93,274
- --------------------------------------------------
In December 1999, the Company completed the acquisition of LeggMason Investors
Holdings plc ("LeggMason Investors"), formerly Johnson Fry Holdings PLC, a
London-based retail fund management company. The acquisition was accounted for
as a purchase. Accordingly, the net assets and results of operations are
included in the Company's consolidated financial statements from the date of
acquisition. The total purchase price was approximately $72,000, including
$67,000 of cash and $5,000 in liabilities. The excess of the purchase price over
the tangible net assets acquired of approximately $64,000 is being amortized on
a straight-line basis over 20 years.
LeggMason Investors has two finance subsidiaries. The purpose of the finance
companies is to raise funds by issuing secured fixed-rate loan securities, with
a minimum maturity of five years, and to use the proceeds to invest in a
portfolio of bonds issued by various financial institutions that are not
generally available to the public in tranches small enough for the retail
investor. See Notes 5 and 7.
On September 30, 1999, the Company entered into a joint venture with Bingham
Dana LLP, a Boston-based law firm, to acquire a 50% interest in its trust
administration business for $10,000. The investment in this joint venture is
being accounted for under the equity method.
On September 2, 1999, the Company acquired the assets of Berkshire Asset
Management, Inc. ("Berkshire") for $18,000. Berkshire provides investment
management services for high net worth individuals and institutions. The
acquisition was accounted for as a purchase. Accordingly, the net assets and
results of operations are included in the Company's consolidated financial
statements from the date of acquisition. The excess of the purchase price over
the tangible net assets acquired of $17,745 is being amortized on a straight-
line basis over periods up to 12 years.
The following unaudited pro forma consolidated results are presented as though
the acquisitions of LeggMason Investors and Berkshire had occurred as of the
beginning of fiscal 2000, adjusted for amortization of the excess of cost over
the net tangible assets acquired.
March 31,
2000
- ------------------------------------------
Net revenues.................. $1,282,896
Net earnings.................. 138,445
Earnings per common share:
Basic........................ $ 2.24
Diluted...................... 2.09
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 $2,746,055 and $2,438,020 as of March 31, 2001, and
2000, respectively. The Company pays interest on certain customer free credit
balances held for investment purposes.
36
4. Financial Instruments Owned, at Fair Value
Securities positions consist of the following at March 31:
Financial instruments
owned
2001 2000
- -----------------------------------------------------
U.S. government and agencies..... $ 10,945 $ 9,136
Corporate debt................... 37,522 22,839
State and municipal bonds........ 73,314 55,529
Equities and other............... 5,407 15,403
- -----------------------------------------------------
$127,188 $102,907
- -----------------------------------------------------
Financial instruments sold,
but not yet purchased
2001 2000
- -----------------------------------------------------
U.S. government and agencies..... $ 34,288 $ 17,894
Corporate debt................... 2,727 8,017
State and municipal bonds........ 762 145
Equities and other............... 1,037 1,657
- -----------------------------------------------------
$ 38,814 $ 27,713
- -----------------------------------------------------
At March 31, 2001, the Company had pledged securities owned of $352 as
collateral to counterparties for securities loaned transactions and for
commodities clearing requirements, which can be sold or repledged.
5. Investments
The Company has two categories of investments: Investment securities and
Investments of finance subsidiaries. These investments are generally classified
as available-for-sale and held-to-maturity as described in Note 1.
Investment securities consist of highly liquid debt and equity securities.
Investments of finance subsidiaries consist of bonds issued by various financial
institutions.
Investments as of March 31, 2001 and 2000 are as follows:
- ---------------------------------------------------------------------
2001 2000
- ---------------------------------------------------------------------
Investment securities:
Available-for-sale............................ $ 13,116 $ 12,102
Held-to-maturity.............................. 784 880
Trading....................................... 150 --
Non-qualifying /(1)/.......................... -- 4,783
- ---------------------------------------------------------------------
Total.......................................... $ 14,050 $ 17,765
- ---------------------------------------------------------------------
Investments of finance
subsidiaries:
Available-for-sale............................ $ 96,320 $102,585
Held-to-maturity.............................. 18,906 139,054
- ---------------------------------------------------------------------
$115,226 $241,639
- ---------------------------------------------------------------------
/(1)/ Non-qualifying for SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities," purposes.
Information regarding the Company's investments, categorized by maturity
date, is as follows:
- -----------------------------------------------------------------------------------------------------------------------------
March 31, 2001 March 31, 2000
- -----------------------------------------------------------------------------------------------------------------------------
Cost/ Gross Gross Cost/ Gross Gross
amortized unrealized unrealized Fair amortized unrealized unrealized Fair
cost gains losses value cost gains losses value
- -----------------------------------------------------------------------------------------------------------------------------
Available-for-sale:
Corporate debt:
Within one year $ 1,469 $ -- $ (69) $ 1,400 $ 232 $ -- $ -- $ 232
Five to ten years 94,032 2,288 -- 96,320 102,649 127 (191) 102,585
U.S. government and
agency securities:
Within one year 697 10 -- 707 490 -- (1) 489
One to five years 249 7 -- 256 940 -- (10) 930
Five to ten years 266 15 -- 281 323 2 -- 325
Over ten years 3,941 160 -- 4,101 4,123 -- (8) 4,115
Equities 5,291 1,125 (45) 6,371 5,172 1,025 (186) 6,011
- -----------------------------------------------------------------------------------------------------------------------------
$105,945 $ 3,605 $ (114) $109,436 $113,929 $1,154 $(396) $114,687
- -----------------------------------------------------------------------------------------------------------------------------
Held-to-maturity:
Corporate debt:
Within one year $ 19,581 $ 169 $ (68) $ 19,682 $ 880 $ -- $ -- $ 880
One to five years -- -- -- -- 138,556 -- (285) 138,271
Other debt securities:
One to five years 109 1 -- 110 498 -- -- 498
- -----------------------------------------------------------------------------------------------------------------------------
$ 19,690 $ 170 $ (68) $ 19,792 $139,934 $ -- $(285) $139,649
- -----------------------------------------------------------------------------------------------------------------------------
37
The proceeds and gross realized gains and losses from sales and maturities of
available-for-sale investments are as follows:
Years ended March 31,
2001 2000 1999
- ---------------------------------------------------------
Proceeds.................. $128,697 $54,104 $51,395
Gross realized gains...... 621 423 --
Gross realized losses..... (39) (493) --
- ---------------------------------------------------------
6. Short-Term Borrowings
The Company obtains short-term financing primarily on a secured basis. The
secured financing is obtained through the use of securities lending agreements
and secured bank loans, which are primarily collateralized by agency, corporate,
and equity securities. The Company had outstanding loan balances of $4,900 and
$23,290 at March 31, 2001 and 2000, respectively. The Company's weighted average
interest rates were 5.58% and 6.32%, respectively.
The Company has a committed, unsecured revolving credit facility of $100,000
that matures on June 30, 2003. The facility has restrictive covenants that
require the Company, among other things, to maintain specified levels of net
worth and debt-to-equity ratios. The Company intends to use the facility for
general corporate purposes including the expansion and diversification of its
business. There were no borrowings outstanding under the facility at March 31,
2001 and 2000. The Company has maintained compliance with the applicable
covenants of the facility at all times.
7. Long-term Debt
The Company has outstanding $100,000 of senior notes due February 15, 2006,
which bear interest at 6.5%. The notes were issued at a discount to yield 6.57%.
At March 31, 2001, the Company had $500,000 available for the issuance of
additional debt or convertible debt securities pursuant to a shelf registration.
As described in Note 2, the Company's finance subsidiaries issued a series of
secured, fixed-rate notes with a minimum maturity of five years. These
obligations become due beginning May 2001 through March 2003 at interest rates
ranging from 6.354% to 7.0%.
The aggregate maturities of long-term debt for each of the five years
subsequent to March 31, 2001 are as follows:
- ----------------------------
2002................$ 26,497
2003................ 100,402
2004................ --
2005................ --
2006................ 100,000
- ----------------------------
Total...............$226,899
- ----------------------------
8. Commitments and Contingencies
The Company leases office facilities and equipment under non-cancelable
operating leases and also has multi-year agreements for data processing and
other services. These leases and service agreements expire on varying dates
through 2013. Certain leases provide for renewal options and contain escalation
clauses providing for increased rentals based upon maintenance, utility and tax
increases. As of March 31, 2001, the minimum annual aggregate rentals are as
follows:
- ----------------------------
2002................$ 62,007
2003................ 51,385
2004................ 38,062
2005................ 28,258
2006................ 21,403
Thereafter.......... 57,099
- ----------------------------
$258,214
- ----------------------------
The table above does not include aggregate rental commitments of $637 for
furniture and equipment under capital leases, most of which is due in 2002.
Rental expense, under all operating leases and service contracts, is $66,945,
$51,935 and $43,370 for 2001, 2000 and 1999, respectively. Rental expense is net
of any sublease income received, which is not material in each of the three
years.
As of March 31, 2001 and 2000, the Company had commitments to invest $9,778
and $15,670, respectively, in limited partnerships that make private equity
investments. These commitments will be funded as required through the end of the
respective investment periods ranging from 2005 to 2010.
The Company enters into when-issued and underwriting commitments. Had the open
transactions relating to these commitments as of March 31, 2001 been closed, the
effect on the consolidated financial statements of the Company would not have
been material.
The Company has been named as a defendant 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, and has been involved in certain
governmental and self regulatory agency investigations and proceedings. While
the ultimate resolution of these actions cannot be currently determined, in the
opinion of management, after consultation with legal counsel, the actions will
be resolved with no material adverse effect on the consolidated financial
statements of the Company. However, if during any period a potential adverse
contingency should become probable, the results of operations in that period
could be materially affected.
38
9. Income Taxes
The components of income tax expense are as follows:
- ----------------------------------------------------
2001 2000 1999
- ----------------------------------------------------
Federal............. $ 85,067 $ 81,499 $49,515
Foreign............. 7,365 7,409 4,096
State and local..... 17,158 15,117 9,926
- ----------------------------------------------------
$109,590 $104,025 $63,537
- ----------------------------------------------------
Current............. $114,549 $109,232 $69,833
Deferred............ (4,959) (5,207) (6,296)
- ----------------------------------------------------
$109,590 $104,025 $63,537
- ----------------------------------------------------
A reconciliation of the difference between the effective income tax rate and
the statutory federal income tax rate follows:
- -------------------------------------------------------------
2001 2000 1999
- -------------------------------------------------------------
Taxes at statutory rates..... $ 93,061 $ 89,053 $54,883
State income taxes,
net of federal income
tax benefit................. 11,153 9,985 6,307
Tax-exempt interest
income, net................. (727) (403) (665)
Life insurance proceeds...... -- -- (1,050)
Goodwill amortization........ 2,017 1,851 963
Foreign losses............... 1,684 1,417 1,265
Higher tax rates
applicable to non-U.S.
earnings.................... 1,408 1,530 804
Other, net................... 994 592 1,030
- -------------------------------------------------------------
$109,590 $104,025 $63,537
- -------------------------------------------------------------
Components of the Company's deferred tax assets and liabilities, included in
other assets and liabilities, are as follows:
- -----------------------------------------------------
2001 2000
- -----------------------------------------------------
Deferred tax assets:
Accrued compensation
and benefits.................... $17,395 $31,800
Accrued expenses................. 9,440 5,892
Operating loss carryforwards..... 6,896 3,697
Amortization of leasehold
improvements.................... 2,965 2,803
Other............................ 1,201 1,017
Valuation allowance.............. (6,875) (3,656)
- -----------------------------------------------------
$31,022 $41,553
- -----------------------------------------------------
Deferred tax liabilities:
Depreciation..................... $ 931 $ 2,922
Deferred expenses................ 1,003 1,479
Deferred income.................. 1,071 3,941
- -----------------------------------------------------
$ 3,005 $ 8,342
- -----------------------------------------------------
At March 31, 2001 and 2000, the deferred tax valuation allowance was primarily
for benefits related to net operating losses. These operating losses have two
components, domestic (state) and foreign. The state net operating losses expire
between 2004 and 2020. The foreign net operating losses will continue until
utilized and otherwise have no expiration date.
10. Employee Benefits
The Company, through its subsidiaries, maintains various defined contribution
plans covering substantially all employees. In addition to discretionary
contributions, the Company matches 50% of employee 401(k) contributions up to 6%
of employee compensation with a maximum of two thousand five hundred dollars per
year. Contributions charged to operations amounted to $27,782, $29,478 and
$18,693 in 2001, 2000 and 1999, respectively. In addition, employees can make
voluntary contributions under certain plans.
11. Capital Stock
At March 31, 2001, the authorized numbers of common, preferred and exchangeable
shares were 250 million, 4 million and an unlimited number, respectively. In
addition, at March 31, 2001 and 2000, there were 13.9 million and 15.1 million
shares of common stock, respectively, reserved for issuance under the Company's
stock option plans and 2.8 million and 5.2 million common shares, respectively,
reserved for exchangeable shares in connection with the Perigee transaction (see
Note 2). Dividends declared but not paid at March 31, 2001, 2000 and 1999 were
$5,878, $4,676 and $3,660, respectively.
The Company effected a 2-for-1 stock split in fiscal 1999. All references in
consolidated financial statements to the number of common shares and per share
amounts have been adjusted retroactively to reflect the stock split, except for
the number of issued common shares presented in the consolidated financial
statements.
12. Stock Plans
At March 31, 2001, 13.9 million shares were authorized to be issued under the
Company's omnibus employee stock plans. In addition, certain employees have the
ability to defer compensation which is payable in shares of Company stock when
vested. There is no limit on the number of shares authorized to be issued under
these deferred arrangements. Options under the Company's employee stock plans
have been granted at prices not less than 100% of the fair market value. Options
are generally exercisable in 20% or 25% increments over 4 to 5 years and expire
within 5 to 10 years from the date of grant.
39
Stock option transactions under the plans during the three years ended March
31, 2001 are summarized below:
- -------------------------------------------------------
Weighted-
average
Number of exercise
shares price
- -------------------------------------------------------
Options outstanding
at March 31, 1998......... 5,761,360 $11.09
Granted.................... 2,734,332 29.95
Exercised.................. (982,668) 7.14
Forfeited.................. (139,889) 17.55
- -------------------------------------------------------
Options outstanding
at March 31, 1999......... 7,373,135 $18.49
Granted.................... 1,613,600 35.84
Exercised.................. (1,349,288) 10.75
Forfeited.................. (193,002) 27.02
- -------------------------------------------------------
Options outstanding
at March 31, 2000......... 7,444,445 $23.43
Granted.................... 2,023,310 51.71
Exercised.................. (1,181,885) 11.80
Forfeited.................. (204,501) 31.72
- -------------------------------------------------------
Options outstanding
at March 31, 2001......... 8,081,369 $32.00
- -------------------------------------------------------
The following information summarizes the Company's stock options
outstanding at March 31, 2001:
- ---------------------------------------------------------------
Weighted- Weighted-
Option average average
Exercise shares exercise remaining life
price range outstanding price (in years)
- ---------------------------------------------------------------
$ 5.48-$12.99... 1,170,016 $ 8.61 1.9
13.00- 22.99... 1,074,906 20.23 3.0
23.00- 34.99... 2,452,529 29.96 6.2
35.00- 53.88... 3,383,918 45.32 6.9
- ---------------------------------------------------------------
At March 31, 2001, 2000 and 1999, options were exercisable on 2,972,113,
2,790,652, and 2,679,080 shares, respectively, and the weighted average exercise
prices were $20.28, $14.54 and $10.38, respectively.
The following information summarizes the Company's stock options exercisable
at March 31, 2001:
- ----------------------------------------------------
Weighted-
Option average
Exercise shares exercise
price range exercisable price
- ----------------------------------------------------
$ 5.48-$12.99.............. 1,162,124 $ 8.61
13.00- 22.99.............. 528,783 20.30
23.00- 34.99.............. 1,041,338 29.69
35.00- 53.88.............. 239,868 35.89
- ----------------------------------------------------
During fiscal 1999, the Company granted 80,000 restricted shares of common
stock at a fair value of $28.16 per share. The restricted shares, granted under
the Company's employee stock plans, vest in 25% increments over four years.
Compensation expense is being recognized over the four-year vesting period. The
restricted stock award was a non-cash transaction. Additionally, during fiscal
1999, the Company entered into a stock purchase and related loan transaction in
which an officer purchased 120,000 shares of common stock valued at $3,379. In
fiscal 2001, 2000 and 1999, the Company recognized $787, $674 and $269,
respectively, in compensation expense for grants made under the Company's stock
plans.
Pro forma results based on the fair value method prescribed in SFAS No. 123 are
as follows:
- -----------------------------------------------------
2001 2000 1999
- -----------------------------------------------------
Net earnings
As reported........... $156,230 $150,413 $93,274
Pro forma............. 146,364 143,903 89,908
Earnings per share
As reported:
Basic................ $ 2.45 $ 2.43 $ 1.57
Diluted.............. 2.30 2.27 1.48
Pro forma:
Basic................ $ 2.29 $ 2.33 $ 1.49
Diluted.............. 2.16 2.17 1.42
- -----------------------------------------------------
The weighted average fair value of stock options granted in fiscal 2001, 2000
and 1999 using an option-pricing model, was $20.15, $13.00 and $9.27 per option
share, respectively. The following weighted average assumptions were used in the
model for grants in fiscal 2001, 2000 and 1999, respectively: expected dividend
yield of .85%, 1.10% and 1.34%; risk-free interest rate of 6.18%, 6.02% and
5.40%; expected volatility of 32.15%, 27.68% and 23.46%; and expected lives of
5.70 years, 6.03 years and 6.37 years.
Pro forma compensation expense associated with option grants is recognized
over the vesting period.
The Company also has a stock option plan for non-employee directors. Options
granted under the plan are immediately exercisable at a price equal to the fair
value of the shares on the date of grant. Options issuable under the plan,
limited to 1.1 million shares in aggregate, have a term of not more than ten
years from the date of grant. At March 31, 2001, options on 489,920 shares have
been granted, of which 389,948 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 4,333,334 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.
40
13. Deferred Compensation Employee Stock Trust
In July 1998, the Emerging Issues Task Force ("EITF") reached a consensus on
EITF Issue 97-14, "Accounting for Deferred Compensation Arrangements Where
Amounts Earned Are Held in a Rabbi Trust and Invested." Under EITF 97-14, assets
of the Trust must be consolidated with those of the employer, and the value of
the employer's stock held in the rabbi trust must be classified in stockholders'
equity and generally accounted for in a manner similar to treasury stock. In
certain situations, the corresponding deferred compensation liability must be
recorded at the fair value of the shares held in the rabbi trust and the changes
in the fair value of the deferred compensation liability after September 30,
1998 must be recognized in earnings. The Company adopted EITF 97-14 to account
for its Deferred Compensation Employee Stock Trust Plan ("Plan") effective
September 30, 1998.
During fiscal 2000, the Company recorded a non-cash credit of $1,063. This
credit represents the change in the fair value of the stock held in trust from
April 1, 1999 to June 2, 1999.
During fiscal 1999, the Company recorded a non-cash charge to earnings of
$10,352. This charge represents the change in the fair value of the stock held
in trust from September 30, 1998 through March 31, 1999.
On June 2, 1999, the Company amended the Plan to limit distributions of Plan
assets to shares of the Company's common stock. In accordance with the
provisions of EITF 97-14, changes in the value of the stock held by the Plan
subsequent to June 2, 1999 no longer affect the Company's earnings. In addition,
as a result of the Plan amendment, the obligation previously recorded as a
deferred compensation liability has been reclassified to stockholders' equity.
Accordingly, the Trust shares (2,855,192 at March 31, 2001 and 2,345,667 at
March 31, 2000) and the corresponding liability are presented as components of
stockholders' equity.
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.
Securities transactions generally settle 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, subject to regulatory and internal requirements. Customer margin
transactions include purchases of securities, sales of securities not yet
purchased and option 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 invests in short-term resale agreements collateralized by U.S.
government and agency securities. The Company generally takes possession of
securities purchased under these agreements. Such transactions expose the
Company to risk in the event the counterparty does not repurchase the securities
and the value of the collateral held is less than the underlying receivable. The
Company monitors the value of the collateral daily and requests additional
collateral when necessary. 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 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.
The Company periodically borrows from banks on a collateralized basis,
utilizing firm and customer margin 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's customer financing and securities lending activities require the
Company to pledge customer securities as collateral for various financing
sources such as bank loans and securities lending. At March 31, 2001, the
Company had approximately $1.4 billion of customer securities under customer
margin loans that are available to be pledged, of which the Company has
repledged approximately $29,094 under securities loan agreements. In addition,
the Company has received collateral of approximately $234,307 under securities
lending agreements, of which the Company has repledged approximately $231,848.
The Company has also received collateral of approximately $2.0 billion under
reverse repurchase agreements for its customer reserve requirement, none of
which has been repledged.
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, 2001, the broker-dealer
subsidiaries had aggregate net capital, as defined, of $291,437, which exceeded
required net capital by $269,192.
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.
41
16. Business Segment Information
The Company provides financial services through four business segments: Asset
Management, Private Client, Capital Markets and Other. Business segment results
include all direct revenues and expenses of the operating units in each business
segment and allocations of indirect expenses based on specific methodologies.
Asset Management provides investment advisory services to Company-sponsored
mutual funds and asset management for institutional and individual clients.
Private Client distributes a wide range of financial products through its
branch distribution network, including equity and fixed income securities,
proprietary and non-affiliated mutual funds and annuities. Net interest profit
from customers' margin loan and credit balances is included in this business
segment.
Capital Markets consists of the Company's equity and fixed income
institutional sales and trading, syndicate, and corporate and public finance
activities. Sales credits associated with underwritten offerings are reported in
Private Client when sold through retail distribution channels and in Capital
Markets when sold through institutional distribution channels. This business
segment also includes realized and unrealized gains and losses on merchant
banking and private equity activities and warrants acquired in connection with
investment banking activities.
Other consists principally of the Company's real estate service business and
unallocated corporate revenues and expenses. In fiscal 2000, pre-tax earnings
include a non-cash deferred compensation credit of $1,063. In fiscal 1999, pre-
tax earnings include a non-cash deferred compensation charge of $10,352. See
Note 13.
Business segment financial results are as follows:
- --------------------------------------------------------------
2001 2000 1999
- --------------------------------------------------------------
Net revenues:
Asset Management.......... $ 445,029 $ 376,660 $289,369
Private Client............ 707,366 694,214 523,851
Capital Markets........... 174,274 157,137 126,787
Other..................... 34,195 37,192 35,689
- --------------------------------------------------------------
$1,360,864 $1,265,203 $975,696
- --------------------------------------------------------------
Earnings before income
tax provision:
Asset Management.......... $ 132,284 $ 129,536 $ 87,322
Private Client............ 113,280 114,215 70,741
Capital Markets........... 15,571 5,027 8,497
Other..................... 4,685 5,660 (9,749)
- --------------------------------------------------------------
$ 265,820 $ 254,438 $156,811
- --------------------------------------------------------------
The Company does not analyze asset information by business segment.
The Company principally operates in the United States, United Kingdom and
Canada. Results by geographic region are as follows:
- ----------------------------------------------------------------
2001 2000 1999
- ----------------------------------------------------------------
Net revenues:
United States............ $1,291,898 $1,217,589 $941,405
United Kingdom........... 36,422 18,894 9,691
Canada................... 32,544 28,720 24,600
- ----------------------------------------------------------------
$1,360,864 $1,265,203 $975,696
- ----------------------------------------------------------------
Earnings before income
tax provision:
United States............ $ 259,466 $ 244,873 $152,390
United Kingdom........... (8,663) (5,732) (3,615)
Canada................... 15,017 15,297 8,036
- ----------------------------------------------------------------
$ 265,820 $ 254,438 $156,811
- ----------------------------------------------------------------
17. Subsequent Events
On May 29, 2001, the Company entered into an agreement to acquire Private
Capital Management, L.P. ("PCM"), a privately owned, high net worth investment
management firm. At March 31, 2001, PCM managed assets of approximately $7.1
billion. Under the terms of the agreement, the Company will pay $682 million in
cash at closing, which is expected to occur during the second quarter of fiscal
2002. The transaction also includes two contingent payments based on PCM's
revenue growth as of the third and fifth anniversaries of closing, with the
aggregate purchase price to be no more than $1.382 billion. The acquisition will
be accounted for as a purchase.
Of the $682 million in cash required at closing, $150 million will be available
from the Company's excess cash and $250 million is being raised through the
private offering of zero coupon convertible notes, as described below. The
Company is currently assessing its financing options with respect to the
remainder of the purchase price.
On May 31, 2001, the Company entered into a purchase agreement for the sale of
$567 million principal amount at maturity of zero coupon convertible notes due
in 2031 resulting in gross proceeds of approximately $250 million (including an
amount covered by an exercised overallotment option). The convertible notes are
being offered to qualified institutional buyers at an initial offering price of
$440.70 per $1,000 principal amount at maturity. The issue price represents a
yield to maturity of 2.75% per annum, with an initial conversion premium of 25%
to the market value of the Company's common stock on the purchase date. Upon
certain events, each note is convertible into 7.7062 shares of the Company's
common stock. The Company may redeem the convertible securities for cash on or
after June 6, 2006 at their accreted value. In addition, the Company may be
required to repurchase the convertible securities at their accreted value, at
the option of the holders, on various dates beginning on June 6, 2003. Such
repurchases can be paid in cash, shares of the Company's common stock or a
combination of both.
42
QUARTERLY FINANCIAL DATA
(Dollars in thousands except per share amounts)
(Unaudited)
Quarter ended
- ----------------------------------------------------------------------------------------------
2001 Mar. 31 Dec. 31 Sept. 30 June 30
- ----------------------------------------------------------------------------------------------
Revenues $380,011 $393,656 $375,769 $386,817
Interest expense 41,266 44,571 45,865 43,687
- ----------------------------------------------------------------------------------------------
Net revenues 338,745 349,085 329,904 343,130
- ----------------------------------------------------------------------------------------------
Non-interest expenses 274,443 279,334 267,108 274,159
- ----------------------------------------------------------------------------------------------
Earnings before income tax provision 64,302 69,751 62,796 68,971
Income tax provision 26,983 28,430 25,590 28,587
- ----------------------------------------------------------------------------------------------
Net earnings $ 37,319 $ 41,321 $ 37,206 $ 40,384
Earnings per share:
==============================================================================================
Basic $ .58 $ .65 $ .58 $ .63
Diluted .55 .61 .55 .60
Cash dividend per share/(1)/ .09 .09 .09 .08
Stock price range:
High 56.99 59.63 60.25 52.38
Low 40.15 42.88 47.63 35.13
Quarter ended
- ----------------------------------------------------------------------------------------------
2000 Mar. 31 Dec. 31 Sept. 30 June 30
- ----------------------------------------------------------------------------------------------
Revenues $419,445 $349,896 $308,825 $321,419
Interest expense 41,236 36,577 28,888 27,681
- ----------------------------------------------------------------------------------------------
Net revenues 378,209 313,319 279,937 293,738
- ----------------------------------------------------------------------------------------------
Non-interest expenses 293,331 253,777 228,900 234,757
- ----------------------------------------------------------------------------------------------
Earnings before income tax provision 84,878 59,542 51,037 58,981
Income tax provision 34,774 24,208 20,732 24,311
- ----------------------------------------------------------------------------------------------
Net earnings $ 50,104 $ 35,334 $ 30,305 $ 34,670
==============================================================================================
Earnings per share:
Basic $ .80 $ .57 $ .49 $ .57
Diluted .75 .54 .46 .52
Cash dividend per share/(2)/ .08 .08 .08 .065
Stock price range:
High 51.25 41.75 40.94 42.88
Low 30.69 30.63 32.56 31.06
- ----------------------------------------------------------------------------------------------
/(1)/ Excluding $.16 per share declared by Perigee prior to acquisition in
quarter ended June 30, 2000.
/(2)/ Excluding $.60 per share declared by Perigee in fiscal 2000.
43
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 2 and 3 of the Company's definitive proxy
statement for the 2001 Annual Meeting of Stockholders and the caption
"Compliance With Section 16(a) of the Securities Exchange Act of 1934" on page
25 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
"Compensation of Directors" on page 4 of the Company's definitive proxy
statement for the 2001 Annual Meeting of Stockholders and the caption "Executive
Compensation" on pages 7 and 8 of the Company's definitive proxy statement for
the 2001 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 pages 5 and 6
of the Company's definitive proxy statement for the 2001 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 14 of the Company's definitive proxy statement
for the 2001 Annual Meeting of Stockholders. Such information is incorporated
herein by reference to the proxy statement.
44
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 28
Consolidated Statements of Earnings 29
Consolidated Statements of Financial
Condition 30
Consolidated Statements of Changes in
Stockholders' Equity 31
Consolidated Statements of Comprehensive Income 32
Consolidated Statements of Cash Flows 33
Notes to Consolidated Financial
Statements 34-42
2. Financial Statement Schedules (included on pages S-1 to S-6 of
this Report):
Report of Independent Accountants on Financial Statement
Schedules
Schedule I - Condensed Financial Statements 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.
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, 2000)
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.
45
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. Stock Option Plan For Non-Employee
Directors, (incorporated by reference to the Company's
Annual Report on Form 10-K for the year ended March 31,
1998)*
10.3 Form of Option Agreement under Legg Mason, Inc. Stock
Option Plan for Non-Employee Directors (incorporated by
reference to Form 10-Q for the quarter ended June 30,
1998)*
10.4 Legg Mason Wood Walker, Incorporated Deferred
Compensation/Phantom Stock Plan (June 1999 Amending
Restatement), (incorporated by reference to the Company's
Annual Report on Form 10-K for the year ended March 31,
1999)*
10.5 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)*
10.6 Form of Option Agreement under Legg Mason, Inc. 1991
Omnibus Long-Term Compensation Plan (incorporated by
reference to the Company's Annual Report on Form 10-K for
the year ended March 31, 1993)*
10.7 Legg Mason, Inc. Executive Incentive Compensation Plan
(incorporated by reference to Appendix A to the definitive
proxy statement for the Company's 2000 Annual Meeting of
Stockholders)*
10.8 Legg Mason, Inc. 1996 Equity Incentive Plan (incorporated
by reference to Registration Statement No. 333-08721 on
Form S-8)*
10.9 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)*
10.10 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)*
10.11 Executive Stock Purchase and Loan Agreement between Legg
Mason, Inc. and an Executive Officer of Legg Mason, Inc.,
dated as of December 8, 1998 (incorporated by reference to
Form 10-Q for the quarter ended December 31, 1998)*
10.12 Restricted Stock Agreement between Legg Mason, Inc. and an
Executive Officer of Legg Mason, Inc., dated as of December
8, 1998 (incorporated by reference to Form 10-Q for the
quarter ended December 31, 1998)*
10.13 Promissory Note of Executive Officer of Legg Mason, Inc.,
dated as December 8, 1998 (incorporated by reference to
Form 10-Q for the quarter ended December 31, 1998)*
10.14 Pledge Agreement by and between Legg Mason, Inc. and an
Executive Officer of Legg Mason, Inc., dated as of December
8, 1998 (incorporated by reference to Form 10-Q for the
quarter ended December 31, 1998)*
46
10.15 Form of Restricted Stock Agreement under the Legg Mason,
Inc. 1996 Equity Incentive Plan*, filed herewith
10.16 Legg Mason Wood Walker, Incorporated Private Client Group
Deferred compensation Plan*, filed herewith
21. Subsidiaries of the Company, filed herewith
23. Consent of independent accountants, filed herewith
_______________
*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, 2001.
47
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
the Board, President and
Chief Executive Officer
Date: June 20, 2001
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 20, 2001
- --------------------------- President and Chief
Raymond A. Mason Executive Officer
(Principal Executive Officer)
/s/ Thomas L. Souders Senior Vice President June 20, 2001
- --------------------------- and Treasurer
Thomas L. Souders (Principal Financial and
Accounting Officer)
/s/ James W. Brinkley Director June 20, 2001
- ---------------------------
James W. Brinkley
/s/ Edmund J. Cashman, Jr. Director June 20, 2001
- ---------------------------
Edmund J. Cashman, Jr.
/s/ Harry M. Ford, Jr. Director June 20, 2001
- ---------------------------
Harry M. Ford, Jr.
/s/ Nicholas J. St. George Director June 20, 2001
- ---------------------------
Nicholas J. St. George
/s/ Richard J. Himelfarb Director June 20, 2001
- ---------------------------
Richard J. Himelfarb
48
/s/ James E. Ukrop Director June 20, 2001
- ---------------------------
James E. Ukrop
Director June 20, 2001
- ---------------------------
Harold L. Adams
/s/ John E. Koerner, III Director June 20, 2001
- ---------------------------
John E. Koerner, III
/s/ Roger W. Schipke Director June 20, 2001
- ---------------------------
Roger W. Schipke
Director June 20, 2001
- ---------------------------
W. Curtis Livingston
/s/ Edward I. O'Brien Director June 20, 2001
- ---------------------------
Edward I. O'Brien
/s/ Peter F. O'Malley Director June 20, 2001
- ---------------------------
Peter F. O'Malley
/s/ Margaret DeB. Tutwiler Director June 20, 2001
- ---------------------------
Margaret DeB. Tutwiler
/s/ William Wirth Director June 20, 2001
- ---------------------------
William Wirth
49
REPORT OF INDEPENDENT ACCOUNTANTS
ON FINANCIAL STATEMENT SCHEDULES
Our report on the consolidated financial statements of Legg Mason, Inc. and
Subsidiaries is included on page 28 in this Form 10-K. In connection with our
audits of such financial statements, we have also audited the related financial
statement schedules listed in the index on page 45 of this Form 10-K.
In our opinion, the financial statement schedules referred to above, when
considered in relation to the basic financial statements taken as a whole,
present fairly, in all material respects, the information required to be
included therein.
/s/ PRICEWATERHOUSECOOPERS LLP
Baltimore, Maryland
May 3, 2001, except
for Note 5, as to
which the date
is May 31, 2001
S-1
Schedule 1
LEGG MASON, INC.
(Parent Company Only)
STATEMENTS OF FINANCIAL CONDITION
(Dollars in thousands)
March 31,
---------------------------------
2001 2000
------------- -----------
ASSETS
Cash and cash equivalents $ 217,033 $ 45,188
Securities purchased under agreements to resell - 110,643
Investment securities, at fair value 3,707 1,272
Intangible assets, net 21,565 -
Investments in and advances
to subsidiaries 780,754 704,155
Other 16,118 21,343
------------- ----------
$ 1,039,177 $ 882,601
============= ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Dividends payable $ 5,624 $ 4,676
Other 6,063 7,394
Senior notes 99,770 99,723
------------- ----------
111,457 111,793
Stockholders' equity
Common stock, par value $.10;
authorized 250,000,000 shares;
issued 62,849,994 in 2001
and 58,599,058 in 2000 6,285 5,860
Shares exchangeable into common stock 10,439 19,527
Additional paid-in capital 330,394 271,687
Deferred compensation and employee note
receivable (36,406) (19,003)
Employee stock trust (81,225) (50,699)
Deferred compensation employee stock trust 81,225 50,699
Retained earnings 624,665 493,696
Accumulated other comprehensive loss, net (7,657) (959)
------------- ----------
927,720 770,808
------------- ----------
$ 1,039,177 $ 882,601
============= ==========
See notes to financial statements.
S-2
Schedule I
LEGG MASON, INC.
(Parent Company Only)
STATEMENTS OF EARNINGS AND COMPREHENSIVE INCOME
(Dollars in thousands)
Years Ended March 31,
------------------------------------
2001 2000 1999
-------- --------- ----------
Revenues
Interest income $ 24,107 $ 16,012 $ 14,916
Other 2,805 353 1,200
--------- --------- ----------
26,912 16,365 16,116
Expenses
Interest expense 6,619 7,357 7,671
Operating expenses 6,718 3,644 9,110
--------- --------- ----------
13,337 11,001 16,781
Earnings before income tax provision and
equity in net earnings of
subsidiaries 13,575 5,364 (665)
Federal and state income tax provision 5,339 958 (1,493)
--------- --------- ----------
Earnings before equity in net
earnings of subsidiaries 8,236 4,406 828
Equity in net earnings of
subsidiaries 147,994 146,007 92,446
--------- --------- ----------
Net earnings $156,230 $ 150,413 $ 93,274
--------- --------- ----------
Other comprehensive income (loss);
Foreign currency translation adjustment (9,111) 365 (1,422)
--------- --------- ----------
Unrealized gains (losses) on investment securities:
Unrealized holding gains (losses) arising
during the period 3,230 866 (1,790)
Reclassification adjustment for (gains) losses
included in net income (582) 42 -
--------- --------- ----------
Net unrealized gains (losses) 2,648 908 (1,790)
Deferred income taxes (235) (152) 671
--------- --------- ----------
Total other comprehensive income (loss) (6,698) 1,121 (2,541)
--------- --------- ----------
Comprehensive income $149,532 $ 151,534 $ 90,733
========= ========= ==========
See notes to financial statements.
S-3
Schedule I
LEGG MASON, INC.
(Parent Company Only)
STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Years Ended March 31,
-----------------------------------------
2001 2000 1999
--------- --------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Earnings $ 156,230 $ 150,413 $ 93,274
Equity in earnings of subsidiaries (144,114) (145,329) (92,446)
Depreciation and amortization 1,193 985 269
(Increase) decrease in assets excluding
acquisitions (220) 4,439 (11,710)
Increase (decrease) in liabilities excluding
acquisitions 4,373 (2,703) 6,035
--------- --------- --------
CASH PROVIDED BY (USED FOR) OPERATING ACTIVITIES 17,462 7,805 (4,578)
--------- --------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net decrease (increase) in securities purchased under agreements
to resell 110,643 (37,627) (30,393)
Purchase of investment securities (4,499) (3,772) (25,544)
Proceeds from sales and maturities of investment securities 2,003 7,038 31,521
Investments in and advances to subsidiaries 65,415 85,949 15,706
Acquisitions, net of cash acquired (16,601) (87,637) -
--------- --------- --------
CASH PROVIDED BY (USED FOR) INVESTING ACTIVITIES 156,961 (36,049) (8,710)
--------- --------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock 21,037 20,780 10,995
Dividends paid (23,615) (24,509) (15,860)
--------- --------- --------
CASH USED FOR FINANCING ACTIVITIES (2,578) (3,729) (4,865)
--------- --------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 171,845 (31,973) (18,153)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 45,188 77,161 95,314
--------- --------- --------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 217,033 $ 45,188 $ 77,161
========= ========= ========
Interest payments were $6,500 in 2001, $6,832 in 2000 and $7,371 in 1999.
No income tax payments were made in 2001, 2000 and 1999.
See notes to financial statements.
S-4
LEGG MASON, INC.
(Parent Company Only)
NOTES TO FINANCIAL STATEMENTS
(Dollars in thousands)
1. Basis of Presentation
---------------------
The Parent Company Only financial statements include the accounts of Legg
Mason, Inc. In addition, all the assets and liabilities of its wholly-owned
subsidiaries are presented in Investments in and advances to subsidiaries.
The Notes to the Consolidated Financial Statements of Legg Mason, Inc. and
Subsidiaries included in Item 8 of this Report include disclosures with respect
to the Parent Company Only.
2. Transactions with Affiliates
----------------------------
Parent Company interest income for 2001, 2000 and 1999 includes $7,448,
$4,091 and $3,558, respectively, arising from promissory notes between the
Parent Company and asset management subsidiaries of the Company. The notes,
$82,369 at March 31, 2001 and $82,938 at March 31, 2000, are included in
Investments in and advances to subsidiaries.
In addition, interest income for 2001, 2000 and 1999 includes $2,876,
$2,526 and $2,865, respectively, principally arising from subordinated loans to
a broker-dealer subsidiary of the Company. The indebtedness, $35,000 at March
31, 2001 and 2000, is included in Investments in and advances to subsidiaries.
All income tax payments are made by Legg Mason Wood Walker, Inc., a wholly-
owned subsidiary.
3. Intangible Assets
-----------------
Intangible assets consist principally of goodwill and asset management
contracts acquired in the purchase of Barrett Associates, Inc. and a 50%
interest in a joint venture with Bingham Dana LLP. Intangible assets are
amortized using a straight-line method over periods not exceeding twenty years.
Accumulated amortization at March 31, 2001 is $570. For a description of the
business combinations, see Note 2 in Notes to Consolidated Financial Statements
of Legg Mason, Inc. and Subsidiaries included in Item 8 of this Report.
4. Deferred Compensation Employee Stock Trust
------------------------------------------
In July 1998, the Emerging Issues Task Force ("EITF") reached a consensus
on EITF Issue 97-14, "Accounting for Deferred Compensation Arrangements Where
Amounts Earned Are Held in a Rabbi Trust and Invested" ("EITF 97-14"). Under
EITF 97-14, assets of the Trust must be consolidated with those of the employer,
and the value of the employer's stock held in the rabbi trust must be classified
in stockholders' equity and generally accounted for in a manner similar to
treasury stock. In certain situations, the corresponding deferred compensation
liability must be recorded at the fair value of the shares held in the rabbi
trust and the changes in the fair value of the deferred compensation liability
after September 30, 1998 must be recognized in earnings. A subsidiary of the
Company adopted EITF 97-14 to account for its Deferred Compensation Employee
Stock Trust Plan ("Plan") effective September 30, 1998.
During fiscal 2000, the subsidiary of the Company recorded a non-cash
credit of $1,063. This credit represents the change in the fair value of the
stock held in trust from April 1, 1999 to June 2, 1999.
During fiscal 1999, the subsidiary of the Company recorded a non-cash
charge to earnings of $10,352. This charge represents the change in the fair
value of the stock held in trust from September 30, 1998 through March 31, 1999.
S-5
On June 2, 1999, the subsidiary of the Company amended the Plan to limit
distributions of Plan assets to shares of the Company's common stock. In
accordance with the provisions of EITF 97-14, changes in the value of the stock
held by the Plan subsequent to June 2, 1999 no longer affect the Company's
earnings. In addition, as a result of the Plan amendment, the obligation
previously recorded as a deferred compensation liability has been reclassified
to stockholders' equity. Accordingly, the Trust shares (2,855,192 at March 31,
2001 and 2,345,667 at March 31, 2000) and the corresponding liability are
presented as components of stockholders' equity at March 31, 2001.
5. Subsequent Events
-----------------
On May 29, 2001, the Company entered into an agreement to acquire all of
the ownership interests in Private Capital Management, L.P.("PCM"), which
manages assets for high net worth individuals, families, endowments, foundations
and selected institutions. Under the terms of the agreement, the Company will
pay $682 million in cash at closing, which is expected to occur during the
second quarter of fiscal 2002. The transaction also includes two contingent
payments based on PCM's revenue growth as of the third and fifth anniversaries
of closing, with the aggregate purchase price to be no more than $1.382 billion.
Of the $682 million in cash required at closing, $150 million will be
available from the Company's excess cash and $250 million is being raised
through the private offering of zero coupon convertible notes, as described
below. The Company is currently assessing its financing options with respect to
the remainder of the purchase price.
On May 31, 2001, the Company entered into a purchase agreement for the sale of
$567 million principal amount at maturity of zero coupon convertible notes due
in 2031 resulting in gross proceeds of approximately $250 million (including an
amount covered by an exercised overallotment option). The convertible notes are
being offered to qualified institutional buyers at an initial offering price of
$440.70 per $1,000 principal amount at maturity. The issue price represents a
yield to maturity of 2.75% per annum, with an initial conversion premium of 25%
to the market value of the Company's common stock on the purchase date. Upon
certain events, each note is convertible into 7.7062 shares of the Company's
common stock. The Company may redeem the convertible securities for cash on or
after June 6, 2006 at their accreted value. In addition, the Company may be
required to repurchase the convertible securities at their accreted value, at
the option of the holders, on various dates beginning on June 6, 2003. Such
repurchases can be paid in cash, shares of the Company's common stock or a
combination of both. See Note 17 in Notes to Consolidated Financial Statements
of Legg Mason, Inc. and Subsidiaries included in Item 8 of this Report.
S-6