- Operating expenses were 17% higher than the first quarter of fiscal 2007, primarily reflecting:
- A $66 million increase in compensation and benefits expenses primarilycat the company''s investment managers related to incentive accruals on increased revenues, including performance fees.
- Distribution expenses paid to third parties as a result of increased distribution revenues that are passed through as a direct cost of selling products.
- Increased occupancy expense and accelerated depreciation related to office relocations.
- Increased investments in technology and data services infrastructure, as well as marketing, promotion and consulting expenses.
- The pre-tax profit margin was 24.4% in the first quarter of fiscal 2007, and the pre-tax profit margin, as adjusted for distribution and servicing expense, was 33.4%.

At both the corporate level and at the individual investment managers, there has been a continued focus on meeting investors'' increasing desire for alpha-oriented and alternative strategies.

An update of initiatives, both recent and ongoing, includes:

- Legg Mason Opportunity Trust, managed by Legg Mason Capital Management, has had successful results since its launch nearly 8 years ago. The fund aims to be a high alpha offering and is notable for its flexible investing strategy unrestrained by investment style, type of security, industry sector, location, size, or market capitalization. The fund can employ a variety of strategies including short-selling and investing in options, hedge funds and other alternative investments.
- The acquisition of the Permal Group over 18 months ago further diversified the company''s investment capabilities by adding exposure to the alternatives market. The Permal Group, with a 32-year history of managing funds-of-hedge funds, has doubled its assets under management since acquisition and currently offers absolute return and directional strategies in multi-manager funds, single manager funds, customized separate accounts and structured products.
- Western Asset Management has managed absolute-return and portable alpha portfolios for client accounts for several years and has recently experienced greater interest in both its absolute return and portable alpha products.
- Brandywine Global Investment Management utilizes a top-down, value- driven process as well as currency valuation strategies when structuring its global and international fixed income portfolios.
- Batterymarch Financial Management offers clients market neutral strategies and in May announced the launch of a 130/30 U.S. Large Cap Equity product to institutional markets.

The company continues to develop products and initiatives to greater realize the potential of the distribution platform acquired in its acquisition of Citigroup Asset Management.

The company announced the launch of two new product offerings in the retail separately managed account (SMA) area that utilize Western Asset Management''s flagship Core and Core Plus strategies. This initiative leverages the company''s distribution scale and expertise in separately managed accounts to offer Western Asset Management''s institutional investment strategies to retail investors. The product launch, in addition to Western Asset Management''s other retail products, further expands the company''s offerings for the growing market of retirees seeking income-oriented products.

Key questions from the first quarter earnings call conducted by Legg Mason on July 24, 2007.

Cynthia Meyer (Merrill Lynch): When you say you want to buy an international asset manager are you looking for primarily somebody with assets invested in non-U.S. strategies or you are most interested in distribution?

Chip Mason: The company is looking primarily in the asset management side of non-U.S., principally it is looking for European, although global, but principally European and U.K. If it gets distribution that would be good but that is not the primary driver.

Cynthia Meyer (Merrill Lynch): When you say that is the priority number one, how do you handle the share repurchases in the meantime?

Chip Mason: Legg Mason’s intent is that it will proceed with what the board had indicated or gave it the authorization to do on an annual, looking at it sort of on an annual basis. If in fact it thought it was going to make or did make an acquisition the assumption is that the company would stop all purchases and use that cash to do the acquisition.

Christopher Spahr (Deutsche Bank): How much was impacted by the client rebalancing on the fixed income side?

Barry Bilson: It is very little. The realization count is done off of those, off of the average assets. The big chunk in the rebalancing is in the liquidity space, the lowest realization rate. It could have touched it, but again, once the company adjusts for a one day in the quarter, it is within like one of the basis points in the mid. it could have impacted but it is moving out into the second decibel place.

Christopher Spahr (Deutsche Bank): How much of these flows were coming from non-U.S. sources?

Chip Mason: It was close to 80 last quarter and it was something like 27 this quarter.

Barry Bilson: If all the liquidity dynamic is adjusted it moves up to a meaningfully higher percentage and it is probably in excess of past.

Bill Katz (Buckingham Research): What do you think the key is to improving the relative performance in the equity business? Is it just style, shift if you will back to domestic and growth, was it something else at play there and how does that impact your thought strategically on acquisition?

Barry Bilson: It is hard to tell because no one knows when one gets in these cycles. In the value cycle in the late 90s, nobody could figure out what was causing it, but somehow this is just underperformance. It is not necessarily out of form. The flows are in the equity side of the business gains, effective in the United States in particular, because the international piece in all those firms that have a disproportionate amount of their assets in the equity international side are doing well right now, because that is where the money is going. Something like 87% of the equity flows were going in the international securities. It is a very high number. Many of the categories are having negative flows. Growth has had negative flows last quarter. This is across the board. When one gets in these trends, unless he has superior performance he is going to suffer and the company has witnessed that. The funds that are having strong performance do seem to be getting flows, may be not phenomenal but, they do seem to be getting flows. Performance is still the key.

Bill Katz (Buckingham Research): Does that shift your timing on acquisitions in light of that?

Chip Mason: If Legg Mason could it would have already done something there. The problem is that the acquisition comes when it comes, and if the company rushes it, it ends up making an acquisition that it may have later wished it did not make.