Legg Mason, Inc. (LM)
Q1 2010 Earnings Call Transcript
July 20, 2009 5:00 p.m. ET

Executives

Alan Magleby – Head of Investor Relations
Mark Fetting – Chairman, Chief Executive Officer
Charles ""C.J."" Daley – Chief Financial Officer

Analysts

William Katz – Buckingham Research
Daniel Fannon - Jefferies & Co
Michael Carrier - Deutsche Bank
Robert Lee - Keefe, Bruyette & Woods
Keith Walsh - Citigroup
Jeffrey Hopson - Stifel Nicolaus & Company
Mario Gabelli - Gabelli & Co
Craig Siegenthaler - Credit Suisse
Roger Smith - Fox-Pitt Kelton
Marc Irizarry - Goldman Sachs
Matthew Snowling - Friedman, Billings, Ramsey

Presentation

Operator

Good day, ladies and gentlemen, and thank you for your patience. You''ve joined the Legg Mason quarterly conference call. (Operator Instructions) At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. Should you require any additional assistance during the call, please press * then 0 on your touchtone telephone. As a reminder this conference maybe recorded. I would now like to turn the call over to your host, Mr. Alan Magleby. Sir, you may begin.

Alan Magleby – Head of Investor Relations

Good afternoon. On behalf of Legg Mason I would like to welcome you to our conference call to discuss operating results for the fiscal 2010 first quarter ended June 30, 2009. This presentation may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not statements of facts or guarantees of future performance and are subject to risks, uncertainties and other factors that may cause actual results to differ materially from those discussed in the statements. For a discussion of these risks and uncertainties, please see risk factors and management''s discussion and analysis of financial condition and results of operations in the company''s annual report on Form 10-K for the fiscal year ended March 31, 2009 and in the company''s quarterly reports on Form 10-Q. This morning''s call will include remarks from Mark Fetting, Legg Mason''s Chairman and CEO, and C.J. Daley, our CFO, who will discuss Legg Mason''s financial results. Following a review of the company''s quarter we will then open the call to Q&A.

Now I would like to turn the call over to Mark Fetting.

Mark Fetting – Chief Executive Officer

Thank you, Alan, and good afternoon, everyone. We appreciate your interest in Legg Mason. While our mission is not yet fully accomplished, we are pleased to have returned Legg Mason to profitability. Legg Mason generated strong cash income, reduced operating expenses and recorded sequential increases in assets under management at five of seven of our core affiliates. Specifically, as you will see on Slide 3 of the companion deck that we put on the website, operating revenues were $613 million for the quarter, down just 1%. Net income on a GAAP basis was $50 million or $0.35 per share. Cash income as adjusted for the quarter was $87 million as it compared to a substantial loss in the prior quarter. Our pre-tax profit margin on a GAAP basis was 13%, but more importantly, as we frequently instructed to take it on a net revenue basis it was 18%. We think this shows good progress.

This represents a good start to fiscal 2010 and reflects the sharp focus of the management team over the past year on the implementation of key strategic initiatives designed to increase our financial strength and flexibility to best position us for improved performance and growth. There is, of course, room for improvement, and today we will share more detail on our progress during the quarter and also discuss the areas that we will continue to focus on going forward.

If you turn to Slide 4, we have to acknowledge that the market environment, while it has been improving, does remain challenging, so we will be very focused on key strategic priorities. Specifically, we''ve completed a scan of both the external marketplace and our internal strengths and weaknesses. We''ve engaged actively with our Board and we''ve concluded and committed to five key priorities. Number one, improving Legg Mason''s financial strength and protect the balance sheet. As a consequence of a large tax refund, our cost savings initiatives and other measures we are implementing, we now have a cash balance of $1.6 billion, including $1.2 billion in excess cash, and we are taking additional steps to enhance our financial strength and protect the balance sheet. Last week, for example, we announced that Legg Mason is proceeding with a tender offer for $1.1 billion in equity units, which will substantially reduce debt levels on our balance sheet. This transaction will be accretive to earnings and cash earnings, excluding transaction costs, and improves our interest coverage ratios. C.J. will provide an update on that shortly.

Priority number two, effectively managing our costs, we end the first quarter having realized our run rate cost savings goal of $160 million. We have improved margins, which reflect operating leverage potential and as performance improves and revenues begin to grow we believe we''ll have the opportunity to improve margins even further. Our compensation ratio for the quarter was 52.7%, just off our target of 50% to 52%, and C.J. will follow on that issue as well.

Priority three, engaging with affiliates on performance, risk management and other strategic initiatives. We think it''s important to note that we did not take any blunt actions during the market turmoil over the last 18 months with regard to our investment affiliates. Now we''re seeing early evidence that this was the right thing to do. Each of our affiliates who had performance issues looked hard at their processes and where they could make improvements they did, whether that was improvements in portfolio construction, risk management and/or new personnel. It is our belief that the best way to optimize the shareholder value in our multi-manager model is to engage our affiliates strategically while respecting their investment autonomy and client accountability. Where we can invest with affiliates to enhance this process we have. Several of our affiliates have seen an opportunity to add some highly regarded talent to the teams because of the dislocation in the markets and where that makes sense we''ve done it.

Priority four, pursue growth, distribution and business development. David Odenath, head of Americas, and Ron Dewhurst, head of International, are pursuing a multi-channel strategy for distribution and a target list of products we think are particularly compelling to investors today, filling in the gaps with new products that meet investor needs while reinforcing existing products with improved track records. Here we believe we are making progress. Our long-term fund flows are showing significant improvement over the last two quarters, with net positive flows in May and June.

And finally, our fifth priority is to continue a build-and-buy growth strategy. As we said in the past, we are looking to opportunistically add to our investment capabilities and offerings. This will include investment in lift-outs and bolt-on acquisitions for our existing affiliates. Slide 5 shows our assets under management, with some breakout. As you see, we ended the quarter at $657 billion, up 4% from the prior quarter. Our asset mix by asset class is 56% in fixed income and 22% each in equity and liquidity. Notably, equity assets are up 13% to $144 billion under management. Slide 6 shifts to net flows and here we''re clearly making progress, but the job is far from done. We experienced a reduction in outflows in this quarter across all asset classes, a trend which has been steadily coming down each of the last two quarters. Net outflows were down 30% as compared to the March quarter and 61% when compared with the December quarter. As a percentage of total AUM, the rate has declined each of the last two quarters from approximately 9% to 6% to just under 5%. In the June quarter, total outflow of $30 billion breaks out as $22 billion in fixed, $6 billion in equity and $2 billion in liquidity. Now, it should be noted that in the fixed income area Western''s outflows decreased and approximately $5 billion of that $22 billion in fixed income relates to expected rebalancing by two large sovereign clients at Brandywine in its global fixed strategy.

Now we shift to Slide 7, which hopefully at this stage analysts are familiar with because it''s one where we show AUM of our key managers in order of their contribution to earnings. Western Asset''s assets were up $10.5 billion for the quarter or approximately 2% due to market appreciation. While it is still early, Western''s RFP activity, unfunded wins and expected flows from many clients are all moving in the right direction, offsetting some of the outflows. More specifically, we see good growth in the global tip strategies, the muni strategies and our business in Brazil. This offsets a continued erosion in the Core/Core Plus strategies, which represents just under 25% of Western Assets. With the improved record, we''re hoping that it is offset. Permal''s assets ended the quarter at $17.2 billion, down from $18.5 billion. The bulk of the outflows in the quarter reflect deferrals from the March quarter. As you may recall, Permal had temporarily moved its notice period to 95 days and are now in the process of transitioning it back to a 20-day period. Redemptions at Permal have returned to pre-Lehman levels. They are also experiencing increased RFP activity, particularly in the high net worth and institutional channels.