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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, 2002
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 24, 2002, 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 $3,346,385,000
As of May 24, 2002, the number of shares outstanding of the
registrant's common stock was 64,861,185. In addition, on that date a subsidiary
of the registrant had outstanding 2,431,094 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 20,
2002 are incorporated by reference into Part III.
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PART I
Item 1. Business.
General
We are a holding company that, through our subsidiaries, is
principally engaged in providing the following services to individuals,
institutions, corporations, governments and government agencies:
. asset management;
. securities brokerage;
. investment banking; and
. other related financial services.
We currently operate through four business segments: Asset Management, Private
Client, Capital Markets and Other.
In our Asset Management business segment, we provide
investment advisory services to company-sponsored investment funds and asset
management services to institutional and individual investors. As of March 31,
2002, our subsidiaries had an aggregate of $177.0 billion of assets under
management. We divide our asset management business into three groups: Mutual
Funds, Institutional and Wealth Management.
In our Mutual Funds business, we sponsor domestic and
international equity, fixed income and money market mutual and closed-end funds
and other proprietary funds. We have two asset management subsidiaries that
primarily focus on managing proprietary investment funds:
. Legg Mason Funds Management, Inc., which is located in
Baltimore Maryland; and
. Royce & Associates, LLC, which is located in New York, New
York.
Our Institutional asset management subsidiaries provide a wide
range of asset management services and products to domestic and international
institutional clients. Our Institutional asset management subsidiaries are:
. Western Asset Management Company and Western Asset Management
Company Limited, which are primarily located in Pasadena,
California and London, England;
. Perigee Investment Counsel Inc., which is primarily located in
Toronto, Canada;
. Brandywine Asset Management, LLC, which is located in
Wilmington, Delaware;
. Batterymarch Financial Management, Inc., which is primarily
located in Boston, Massachusetts;
. Legg Mason Capital Management, Inc., which is located in
Baltimore, Maryland; and
. Legg Mason Investors Holdings plc, which is located in London,
England.
Our Wealth Management subsidiaries provide customized,
discretionary investment management services and products to high net worth
individuals and families, endowments and foundations and institutions. Our
Wealth Management subsidiaries are:
. Private Capital Management, L.P., which is located in Naples,
Florida;
. Bartlett & Co., which is primarily located in Cincinnati Ohio;
. Barrett Associates, Inc., which is located in New York,
New York;
. Gray, Seifert & Co., Inc., which is located in New York,
New York;
. Berkshire Asset Management, Inc., which is located in Wilkes-
Barre, Pennsylvania;
. Legg Mason Focus Capital, Inc., which is primarily located in
Bala Cynwyd, Pennsylvania; and
. Legg Mason Trust, fsb, which is located in Baltimore Maryland.
Our Private Client and Capital Markets business segments are
primarily conducted through Legg Mason Wood Walker, Incorporated ("Legg Mason
Wood Walker"), our principal broker-dealer subsidiary. Legg Mason Wood Walker is
a full service broker-dealer, investment adviser and investment banking firm
operating primarily in the Eastern and Southern regions of the United States.
Our Other business segment consists primarily of the
operations of Legg Mason Real Estate Services, Inc., our principal real estate
finance subsidiary. Legg Mason Real Estate Services 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 - Fiscal 2002 Compared With Fiscal 2001 -
Revenues By Segment" for the net revenues and pre-tax earnings of each of our
business segments. See Note 17 of Notes to Consolidated Financial Statements in
Item 8 of this Report for the net revenues and pre-tax earnings generated by
Legg Mason in each of the four principal geographic areas in which we conduct
business.
Legg Mason, Inc. 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. Our subsequent growth has occurred through
internal expansion as well as through the acquisition of asset management,
broker-dealer and commercial mortgage banking firms.
Unless the context otherwise requires, all references in this
Report to "we," "us," "our" and "Legg Mason" include Legg Mason, Inc. and its
predecessors and subsidiaries.
2
Revenues by Source
This table shows information about our revenues by source.
LEGG MASON, INC. AND SUBSIDIARIES
Years Ended March 31,
----------------------------------------------------------------------------------------------
2002 2001 2000
---- ---- ----
(Dollars in thousands)
Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ -------
Investment Advisory and
Related Fees $ 781,572 53.9% $ 653,992 48.1% $ 563,463 44.5%
Commissions:
Listed and Over-the-
Counter 212,531 14.6 217,769 16.0 229,930 18.2
Mutual Funds 80,276 5.5 90,363 6.6 82,949 6.6
Insurance and Annuities 31,547 2.2 40,931 3.0 40,247 3.2
Options 6,539 0.5 9,499 0.7 9,761 0.7
------------- ----------- ------------ ----------- ------------- -----------
Total 330,893 22.8 358,562 26.3 362,887 28.7
Principal Transactions (1)
Customer Related:
Government and Agency 43,725 3.0 17,340 1.3 16,783 1.3
Municipal 28,809 2.0 34,178 2.5 39,244 3.1
Corporate Debt 28,829 2.0 23,723 1.7 21,157 1.7
Equities 25,513 1.8 39,716 2.9 36,183 2.9
------------- ----------- ------------ ----------- ------------- -----------
126,876 8.8 114,957 8.4 113,367 9.0
Dealer Related:
Government and Agency 3,143 0.2 2,406 0.2 2,327 0.2
Municipal 1,626 0.1 977 0.1 932 0.1
Corporate Debt 2,602 0.2 1,837 0.2 405 0.0
Equities 4,653 0.3 4,379 0.3 9,236 0.7
------------- ----------- ------------ ----------- ------------- -----------
12,024 0.8 9,599 0.8 12,900 1.0
------------- ----------- ------------ ----------- ------------- -----------
Total 138,900 9.6 124,556 9.2 126,267 10.0
Investment Banking:
Corporate 88,424 6.1 59,607 4.4 60,792 4.8
Municipal 13,760 0.9 6,270 0.4 8,113 0.7
------------- ----------- ------------ ----------- ------------- -----------
Total 102,184 7.0 65,877 4.8 68,905 5.5
Interest Income 168,073 11.6 282,201 20.7 223,030 17.6
Other (2) 56,990 3.9 51,065 3.8 55,033 4.3
------------- ----------- ------------ ----------- ------------- -----------
Total Revenues 1,578,612 108.8 1,536,253 112.9 1,399,585 110.6
Interest Expense 127,271 8.8 175,389 12.9 134,382 10.6
------------- ----------- ------------ ----------- ------------- -----------
Net Revenues $ 1,451,341 100.0% $ 1,360,864 100.0% $ 1,265,203 100.0
============= =========== ============ =========== ============= ===========
(1) Principal transactions (securities transactions in which we buy for or sell
from our own inventory) are classified as "Customer Related" when they are
effected with a customer (whether an individual or institutional investor)
and as "Dealer Related" when they are effected with another dealer.
(2) Includes revenues from commercial mortgage servicing and commercial loan
originations in fiscal years 2002, 2001 and 2000 of $23,751, $20,648 and
$23,176, respectively.
3
Asset Management Business Segment
Our Asset Management business segment provides investment
advisory services to company-sponsored investment funds and asset management
services to institutional and individual investors. Operating out of offices
primarily located in the United States, and also located in Canada, the United
Kingdom and Singapore, our asset management subsidiaries provide a broad array
of investment management products and services. Our investment products include
proprietary mutual funds ranging from money market and fixed income funds to
equity funds managed in a wide variety of investing styles, non-United States
funds and unregistered, alternative investment products.
As of March 31, 2002, our subsidiaries had an aggregate of
$177.0 billion of assets under management, of which approximately 38% was in
equity related products and approximately 62% was in fixed income related
products. During the year ended March 31, 2002, our assets under management grew
by 27%, primarily as a result of acquisitions of, and subsequent growth of
acquired, asset management companies and growth in assets managed in fixed
income advisory accounts resulting from net client inflows.
Our asset management business has had steady growth over the
last ten years, both in absolute terms and in terms of the percentage of our
revenues and profits that it generates. During that period, our assets under
management have grown from $10.9 billion to $177.0 billion and our investment
advisory and related fee revenues, which include distribution and service
revenues that are included in the Private Client business segment, have grown
from $67.9 million to $781.6 million. This growth in our asset management
business has occurred through both internal growth and strategic acquisitions of
asset management businesses. It is Legg Mason's strategy to continue to grow our
asset management business, both in absolute terms and as percentages of our
total revenues and profits.
We conduct our asset management business primarily through 16
subsidiaries. Each of these subsidiaries generally focuses on a different aspect
of the asset management business in terms of the types of assets managed
(primarily equity or fixed income), the types of products and services offered,
the investment styles utilized, the distribution channels used and the types and
geographic locations of its clients. These subsidiaries are generally operated
as individual businesses, in many cases with certain administrative functions
being provided by the parent company, that market their products and services
under their own brand names. Consistent with this approach, we have in place
revenue sharing agreements with Legg Mason Funds Management, Legg Mason Capital
Management, Royce & Associates, Western Asset Management Company, Brandywine
Asset Management, Batterymarch Financial Management, Private Capital Management,
Bartlett & Co., Barrett Associates and Berkshire Asset Management and/or certain
of their key officers. Pursuant to these revenue sharing agreements, a specified
percentage of the subsidiary's revenues is required to be distributed to us, and
the balance of the revenues is retained to pay operating expenses, including
salaries and bonuses, with specific expense and compensation allocations being
determined, subject to our approval, by the subsidiary's management.
We divide our asset management business into three groups:
Mutual Funds, Institutional and Wealth Management. Mutual Funds encompasses the
subsidiaries that are primarily engaged in providing investment advisory
services to proprietary mutual and closed-end funds and the proprietary funds
operations of our other asset managers. Our Institutional managers are our
subsidiaries that focus on providing asset management services for institutional
clients. Our Wealth Managers are our subsidiaries that focus on providing asset
management services for high net worth individuals and family groups. There is
overlap among the three groups of subsidiaries as many of our Institutional and
Wealth Management subsidiaries also manage mutual funds that are included in
Mutual Funds and each manager may provide asset management services to other
types of clients. These groups are described in more detail below.
Our assets under management mix is as follows: Mutual Funds-
$37.3 billion; Institutional-$119.3 billion and Wealth Management-$20.4 billion.
Mutual Funds includes all assets in our proprietary investment funds and all
separate accounts managed by our Mutual Funds subsidiaries. Institutional
includes all non-proprietary investment fund assets managed by our Institutional
managers. Wealth Management includes all
4
non-proprietary investment fund assets managed by our Wealth Managers. In
addition, assets managed by other subsidiaries that are not part of our Asset
Management business segment are included in Institutional or Wealth Management
as appropriate.
Mutual Funds
In our Mutual Funds group, we sponsor domestic and
international equity, fixed income and money market mutual and closed-end funds
and other proprietary funds. Our mutual funds business primarily consists of
two families of proprietary mutual and closed-end funds, the Legg Mason Funds
and the Royce Funds. The Legg Mason Funds are 22 separate mutual funds that
invest in a wide range of domestic and international equity and fixed income
securities utilizing a number of different investment styles. The Royce Funds
are 14 separate mutual funds and three closed-end funds that invest in small-
and micro-cap domestic company stocks using a value investment approach. Of our
$37.3 billion in Mutual Funds assets as of March 31, 2002, $27.2 billion were in
these two proprietary mutual fund families.
The Legg Mason Funds consist of 22 separate mutual funds. Of
these funds, three are money market portfolios, seven invest primarily in
taxable or tax-free fixed income securities, nine invest primarily in domestic
equity securities and three invest primarily in international equity securities.
Investment objectives for the Legg Mason Funds include a variety of strategies.
Equity investment strategies may emphasize large-cap, mid-cap or small-cap
investing and capital appreciation and/or income investment objectives. The
largest of the Legg Mason Funds is Legg Mason Value Trust, Inc., which has
received wide recognition for its investment performance over the last eleven
calendar years.
Legg Mason Funds Management, Inc. is the primary equity
investment advisor to the Legg Mason Funds. Legg Mason Funds Management serves
as investment advisor to four of the equity funds in the Legg Mason Funds
family, including Legg Mason Value Trust, Inc. Legg Mason Funds Management also
subadvises the mutual fund managed by the joint venture described below and
investment products sponsored by Perigee and Legg Mason Investors. Legg Mason
Funds Management's investment process uses a variety of qualitative and
quantitative techniques to develop an estimate of the worth of a business over
the long term. The objective is to identify companies where the value of the
business is significantly higher than the current stock price. We also own 50%
of a joint venture with one of our employees that serves as investment manager
of one equity fund within the Legg Mason Funds family.
In addition to Legg Mason Funds Management and the joint
venture, a number of our other subsidiaries manage Legg Mason Funds. Western
Asset Management Company is investment advisor to four taxable fixed income
funds and two taxable money market funds, Legg Mason Trust, fsb serves as
investment adviser to three tax-exempt fixed income funds and one tax-exempt
money market fund, Batterymarch Financial Management serves as investment
advisor to two international funds, Brandywine Asset Management serves as
investment advisor to two equity funds, and Bartlett & Co. and Gray, Seifert
each serve as investment advisor to one equity fund. In addition, one
international fund is managed by an unaffiliated investment advisor.
The Royce Funds consist of 14 separate mutual funds and three
closed-end funds that invest in small-cap and micro-cap domestic company stocks.
The investment objective of each of these funds is long-term appreciation of
capital using a value approach. Several of the funds also have a secondary
objective of providing current income. The funds differ in whether they are
invested in small-cap stocks, micro-cap stocks or a mix of the two and in
whether they are invested in the securities of a concentrated, small number of
companies or a diversified, larger number of companies. Further, two of the
funds are used as investment vehicles for insurance products.
Royce & Associates, LLC is investment advisor to all of the
Royce Funds. In addition, Royce & Associates also manages other accounts that
invest primarily in small-cap and micro-cap company stocks, using a value
approach. Royce & Associates' stock selection process seeks to identify
companies with strong balance sheets, solid records of growth, and the ability
to generate free cash flow. Royce & Associates pursues securities that are
priced below their estimate of current worth. We acquired Royce & Associates
in October 2001.
5
Our proprietary mutual funds are distributed through a number
of channels. Legg Mason Wood Walker is the principal underwriter for the Legg
Mason Funds. The Legg Mason Funds are primarily distributed to retail investors
through our Private Client Group financial advisors and through proprietary
funds marketing departments. The Royce Funds are primarily distributed through
non-affiliated funds supermarkets, non-affiliated wrap programs, direct
distribution and our Private Client Group financial advisors. In addition, two
of the portfolios in the Royce Funds are distributed only through insurance
companies. For the fiscal years ended March 31, 2002, 2001 and 2000, we received
from our proprietary mutual funds and offshore investment funds approximately
$157.5 million, $168.2 million and $158.8 million, respectively, in asset-based
distribution and service fees, which are included in the Private Client business
segment.
Our Mutual Funds group also includes the Western Asset Funds,
a proprietary family of mutual funds that are marketed primarily to
institutional investors. Western Asset Management Company sponsors these funds,
and manages them using a team approach under the supervision of Western Asset's
investment committee. The funds primarily invest in fixed income securities. The
Western Asset Funds, and the institutional and financial intermediary classes of
the Legg Mason Funds are marketed to institutional investors by a proprietary
funds marketing department.
Our Mutual Funds group also includes four groups of
proprietary funds that are sponsored and managed by our Institutional managers
and Legg Mason Funds Management and are offered and sold only outside the U.S.
to non-U.S. persons. Both the Legg Mason Global Funds, a family of 13 funds that
are managed by Western Asset, Legg Mason Funds Management and Batterymarch
Financial Management, and three other funds that are managed by Western Asset
are domiciled in the Netherlands Antilles. Domiciled in Ireland are four funds
managed by Western Asset and an equity fund managed by Legg Mason Funds
Management. The Legg Mason Worldwide family of funds is three funds domiciled in
Luxembourg and managed by Batterymarch Financial Management. Finally, Brandywine
Asset Management operates a hedge fund that is based in the Cayman Islands.
Institutional
Our Institutional managers provide a wide range of asset
management services and products to domestic and international institutional
clients. These subsidiaries manage a range of domestic, international and global
equity, balanced, fixed income and cash management portfolios for their
institutional clients. Our domestic and international institutional clients
include pension and other retirement funds, corporations, insurance companies,
endowments and foundations and governments. Our seven Institutional asset
management subsidiaries are described below.
As of March 31, 2002 and 2001, our Institutional asset
management subsidiaries managed assets with a value of $118.5 billion and $101.9
billion, respectively (excluding assets with a value of $12.0 billion and $10.4
billion, respectively, in proprietary funds managed by these subsidiaries).
These numbers also exclude $0.8 billion and $1.7 billion, respectively, of
institutional assets managed by subsidiaries outside of our Asset Management
business segment. Over 75% of the assets managed by our Institutional managers
are in fixed income accounts managed by Western Asset and Western Asset Limited.
Similarly, the growth in assets managed by these subsidiaries during the fiscal
year primarily resulted from growth in fixed income accounts managed by Western
Asset and Western Asset Limited, supplemented by growth in assets managed by
Brandywine, Legg Mason Capital Management and Batterymarch, and partially offset
by a decline in assets managed by Perigee.
Western Asset Management Company is a leading fixed income
asset manager for institutional clients. Among the services Western Asset
Management provides are management of separate accounts and management of mutual
funds, closed-end funds and other structured investment products. Based in
Pasadena, California, Western Asset Management offers over 25 fixed income asset
management products, including its "core" and "core plus" products. Western
Asset targets four key areas in managing fixed income portfolios -sector
allocation, issue selection, duration exposure and term structure weighting. For
global portfolios, country/currency allocation is a fifth key area.
6
Western Asset Management Company Limited contains the United
Kingdom operations of Western Asset Management Company. Based in London, Western
Asset Management Company Limited manages non-United States dollar currency and
fixed income assets for many of the international clients of Western Asset
Management.
Perigee Investment Counsel Inc. is an institutional investment
manager in Canada. The types of clients for whom Perigee provides investment
management services include: pension plans for public and private sector
entities, managed on both a separate account and pooled basis; third-party
mutual funds; government sponsored funds; insurance companies; trusts and
foundations; and individual investors, whose portfolios are managed separately
or on a pooled basis. Perigee offers products managed in a number of different
equity and fixed income investment styles.
Brandywine Asset Management, LLC manages equity portfolios for
institutional and, through wrap accounts, high net worth individual clients and
manages global fixed income accounts for institutional clients. Brandywine,
based in Wilmington, Delaware, pursues one investment approach-value
investing-and is known for its "classic" or "deep" value equity management
style.
Batterymarch Financial Management, Inc. manages U.S.,
international and emerging markets equity portfolios for institutional clients.
Batterymarch also subadvises investment products sponsored by Perigee. Based in
Boston, Massachusetts, Batterymarch is known for its quantitative approach to
asset management. The firm's investment process for U.S. and international
portfolios is designed to enhance the fundamental investment disciplines by
using quantitative tools to process fundamental data.
Legg Mason Capital Management, Inc. manages equity portfolios
primarily for institutional accounts. Legg Mason Capital Management and Legg
Mason Funds Management are generally operated as a single business, and Legg
Mason Capital Management manages client portfolios using the same management
style and approaches that are used by Legg Mason Funds Management to manage its
proprietary funds.
Legg Mason Investors Holdings plc primarily manages unit and
investment trusts, which are similar to open and closed-end funds in the United
States, for investors in the United Kingdom. Legg Mason Investors utilizes a
team-oriented, research-driven approach to investment management. The firm's
approach is to seek industries that it believes are poised for future growth
and invest in companies within those industries based on market leadership,
management compabilities, cash flow generation and valuation. Legg Mason
Investors generally employs a growth investment style.
Wealth Management
Our Wealth Managers provide customized, discretionary investment
management services and products to high net worth individuals and families,
endowments and foundations and institutions. Our Wealth Managers seek to provide
portfolio management, client service and other financial services in a
disciplined manner that is tailored to meet our clients' particular needs and
objectives. This group includes six asset management subsidiaries, our trust
company subsidiary and a joint venture, all of which are described in more
detail below.
As of March 31, 2002 and 2001, our Wealth Management
subsidiaries managed assets with a value of $17.6 billion and $5.9 billion,
respectively (excluding assets with a value of $0.9 billion and $0.9 billion,
respectively, in proprietary funds managed by these subsidiaries). These numbers
also exclude $2.8 billion and $2.6 billion, respectively, of wealth management
assets managed by subsidiaries outside of our Asset Management business segment.
A majority of the assets managed by our Wealth Managers are managed by Private
Capital Management,L.P. Similarly, the growth in assets under management by
these subsidiaries during the fiscal year primarily resulted from the
acquisition and subsequent growth of Private Capital Management.
Private Capital Management, L.P. manages equity assets for
high net worth individuals and families, institutions, endowments and
foundations in separate accounts and limited partnerships. Based in Naples,
Florida, Private Capital Management's value-focused investment philosophy is
based on an analysis of a company's
7
free cash flow. In executing this philosophy, Private Capital Management seeks
to build a portfolio consisting of securities of companies that possess several
basic elements, including significant free cash flow, a substantial resource
base, and a management team with the ability to correct problems that have been
excessively or inappropriately discounted by the public markets. Ultimately,
Private Capital Management seeks to find and to capture for its clients
undiscovered value that is not yet recognized in a company's stock price. Legg
Mason acquired Private Capital Management in August 2001.
Bartlett & Co. manages balanced, equity and fixed income
portfolios for high net worth individual and institutional clients. Bartlett
operates out of offices in Cincinnati and Dayton, Ohio and Indianapolis,
Indiana. Bartlett follows a value investment philosophy. Bartlett's research and
stock selection criteria emphasize a variety of fundamental factors, and they
seek to invest in companies that generally possess some combination of the
following characteristics: financial strength, potential for growth of earnings
and dividends, attractive profitability characteristics, sustainable competitive
advantage, and shareholder-oriented management.
Barrett Associates, Inc. (70% owned), is an equity asset
manager for high net worth individuals and family groups, endowments and
foundations. Based in New York, New York, Barrett Associates' focus is to build
wealth for their clients through the selection of stocks of high quality
companies. Barrett delivers services through separately managed portfolios for
individuals and institutions as well as through their proprietary mutual fund,
the Barrett Growth Fund.
Gray, Seifert & Co., Inc. primarily manages equity portfolios
for high net worth individuals and family groups, endowments and foundations.
Based in New York, New York, Gray, Seifert's approach to portfolio management is
geared toward long-term creation and preservation of wealth. Gray, Seifert uses
a current earnings approach to equity investing, and follows six principles of
investing: investment themes, current earnings growth, dividend growth, strong
balance sheet, relative value, and hands-on research.
Berkshire Asset Management, Inc. provides equity, balanced,
and intermediate duration high quality fixed income money management services to
individuals and institutions through separate accounts and limited partnerships.
Based in Wilkes-Barre, Pennsylvania, Bershire seeks to invest in high quality
businesses that are selling at prices below Berkshire's estimate of intrinsic
value. They believe over the long-term, equity prices are driven by an issuer's
ability to generate free cash flow and purchasing securities of these businesses
at discounts to intrinsic value provides for appreciation potential and reduces
risk.
Legg Mason Focus Capital, Inc. is focused on serving the
investment needs of high net worth investors and their related accounts. They
are primarily equity investors and feature three products: Focus Global Equity,
Whole Market Equity and Core Equity Income Plus. Focus Capital believes that the
market reflects all available public information, and that active management
adds value to an index over time by distinguishing information which is
reflected accurately from that which is distorted.
Legg Mason Trust, fsb is a federally chartered unitary thrift
institution with authority to exercise trust powers. Legg Mason Trust provides
services as a trustee for trusts established by our individual and employee
benefit plan clients and manages fixed income and equity assets. Through various
subsidiaries, Legg Mason provides brokerage and asset management services for a
significant portion of the assets held in Legg Mason Trust's accounts.
Bingham Legg Advisers LLC is a joint venture that is equally
owned by Legg Mason and Bingham Dana LLP, a Boston-based law firm. Bingham Legg
Advisers seeks to provide a coordinated approach to the financial needs of the
high net worth market. Bingham Legg limits its focus to clients with a minimum
of $1 million to invest and then seeks to provide them a high level of personal
service.
Each Wealth Management subsidiary retains its own investment
style and regional operations, seeking to generate ongoing growth in its core
business through direct new business efforts in its market. In addition to these
core efforts, we offer a new wealth management program, directAdvantage(SM),
which is designed to provide our Private Client Group financial advisors with a
single platform through which they can deliver the full range of
8
our wealth management investment advisory services to our brokerage clients. The
directAdvantage initiative is a fee-based program enabling brokerage clients to
pay a single, asset-based fee and receive custody, recordkeeping, consolidated
reporting, transaction execution, and investment advisory services.
Private Client Business Segment
Our Private Client business segment distributes a wide range
of financial products through its branch distribution network, including equity
and fixed income securities, proprietary and non-affiliated mutual funds and
annuities. This business segment consists principally of the operations of Legg
Mason Wood Walker.
Private Client Securities Business
For the fiscal years ended March 31, 2002, 2001 and 2000, our
revenues derived from securities transactions for individual investors
(excluding interest on margin accounts) constituted approximately 66%, 78% and
80%, respectively, of our total revenues from securities transactions and 24%,
29% and 32%, respectively, of our net revenues. Despite a significant decline in
the percentage of revenues contributed by our Private Client securities business
as a result of difficult market conditions and an increase in asset management
revenues, we believe that these services will continue to be a significant
source of our revenues in the foreseeable future, although the percentage of net
revenues they provide may continue to decrease primarily as a result of
increases in asset management revenues. We charge retail commissions on both
exchange and over-the-counter ("OTC") transactions in accordance with an
internal schedule. We will grant discounts from the schedule in certain cases.
We also offer account arrangements under which a single fee is charged based on
a percentage of the assets held in a customer's account and no charge is imposed
on a transaction-by-transaction basis. This single fee covers all execution and
advisory services, including advisory services provided by our asset management
subsidiaries and selected independent advisory firms. In addition, we provide
asset allocation and advisor performance and selection consultation services.
When we execute OTC transactions as a dealer, we receive, in lieu of
commissions, mark-ups or mark-downs that are included in the "Revenues by
Source" table as customer-related principal transactions. We have entered into
dealer-sales agreements with a number of major distributors that offer mutual
fund shares through broker-dealers. In addition, we sell shares of our
proprietary mutual funds through our retail sales network. See "Asset Management
Business Segment -- Mutual Funds."
9
Brokerage Offices
This table shows, as of March 31, 2002, information with respect to our
retail securities brokerage offices.
Number of
Financial Number of
Location Advisors Offices
-------- --------- ---------
United States:
Maryland 304 18
Pennsylvania 178 21
Virginia 141 17
Florida 84 12
North Carolina 76 10
Louisiana 76 7
Ohio 51 8
Massachusetts 48 3
South Carolina 45 4
New Jersey 44 5
Mississippi 40 4
Texas 39 4
New York 37 4
District of Columbia 37 1
Alabama 26 4
Tennessee 20 3
Maine 15 1
West Virginia 14 2
Georgia 12 1
Connecticut 10 2
Rhode Island 7 1
Delaware 6 1
New Hampshire 2 1
----- ----
Total 1,312 134
===== ====
Margin Accounts, Interest Income and Free Credit Balances
We effect customers' securities transactions on either a cash
or margin basis. In a cash transaction, the customer pays the price for the
securities in cash. In a margin transaction, the customer pays less than the
full cost of the securities purchased and we make a loan for the balance of the
purchase price. The loan is 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
our internal policies. In some instances, our internal policies are more
stringent than Regulation T or NYSE requirements. In permitting a customer to
purchase securities on margin, we are subject to the risks that a market decline
could reduce the value of our collateral below the amount of the customer's
indebtedness and that the customer might be unable otherwise to repay the
indebtedness.
We charge interest on amounts borrowed by customers (debit balances) to
finance their margin transactions. The rate of interest we charge is the prime
rate plus or minus an additional amount that varies
10
depending upon the amount of the customer's average debit balance. Interest
income derived from these sources constituted approximately 3%, 5% and 5%, of
our net revenues for the 2002, 2001 and 2000 fiscal years, respectively. We also
earn interest on securities we own and on operating and segregated cash
balances.
We finance customers' margin account borrowings primarily through free
credit balances (excess funds held by customers in their brokerage accounts). We
pay interest on free credit balances in Legg Mason Wood Walker customers'
accounts when the customer has indicated that the funds will be used for
reinvestment at a future date. In fiscal 2002, we paid interest on approximately
92% of Legg Mason Wood Walker's retail customer free credit balances.
Insurance Brokerage and Financial Planning
Substantially all of our financial advisors are licensed to sell
insurance. Our subsidiary Legg Mason Financial Services, Inc. acts as general
agent for several life insurance companies and sells fixed and variable
annuities and insurance. We also offer, through Legg Mason Wood Walker,
financial planning services to individuals. See "Revenues by Source" for
information regarding revenues generated by insurance brokerage activities.
Other Services
At March 31, 2002, Legg Mason Wood Walker served as a non-bank
custodian for approximately 384,000 IRAs, 30,000 Simplified Employee Pension
Plans and 16,000 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
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, Boston and Chicago stock
exchanges.
Capital Markets Business Segment
Our Capital Markets business segment is conducted primarily through
Legg Mason Wood Walker. This segment consists of our:
. equity and fixed income institutional sales and trading;
. syndicate; and
. corporate and public finance activities.
Institutional Business
We execute securities transactions for institutional investors such as
banks, mutual funds, insurance companies and pension and profit-sharing plans.
These investors typically purchase and sell securities in large quantities that
require special marketing and trading expertise. We believe that we receive a
significant portion of our institutional brokerage commissions as a consequence
of providing research opinions and services regarding specific corporations and
industries and other matters affecting the securities markets. See "Research."
We execute transactions as a broker or as a principal. We generally
offer discounts from our commission schedule to our institutional customers. The
size of these discounts varies with the size of particular transactions and
other factors. For the fiscal years ended March 31, 2002, 2001 and 2000, the
revenues we derived from securities transactions for institutional investors
constituted approximately 34%, 22% and 20%, respectively, of our total revenues
from securities transactions and 12%, 8% and 8% of our net revenues.
11
Principal Transactions
We are a market maker in equity securities that are traded on the
Nasdaq Stock Market. We also are 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, 2002, we made markets in equity securities of
approximately 255 corporations, including corporations for which we have acted
as a managing or co-managing underwriter. Among our traders, 49 are involved in
trading corporate equity and debt securities, 14 are involved in trading
municipal securities, 6 involved in trading government securities and 6 are
involved in trading mortgage-backed securities.
Our market-making activities are also conducted with other dealers, and
with institutional and individual customers of our branch office system. We
allocate mark-ups and mark-downs from market-making activities to the Private
Client business segment when the transaction involves an individual client. In
making markets in equity and debt securities, we maintain positions in the
securities to service our customers and accordingly expose our capital to the
risk of fluctuations in market value. We realize profits and losses from market
fluctuations in these securities, although we generally seek to avoid
substantial market risk, and may engage in hedging transactions to reduce risk.
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
We participate as an underwriter in public offerings of corporate debt
and equity issues and municipal securities. We also manage or co-manage some of
these offerings.
The following tables show, for the periods indicated, (i) the total
number and dollar amount of corporate stock and bond and municipal bond
offerings we managed or co-managed, and (ii) the total number and dollar amount
of our underwriting participations in both those offerings and offerings managed
by others.
Managed or Co-Managed Offerings
------------------------------------------------------
Calendar Year Number of Issues Amount of Offering
- ------------- ---------------- ------------------
Corporate Municipal Corporate Municipal
--------- --------- --------- ---------
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
2001 59 301 11,636,469,000 8,485,172,000
12
Underwriting Participations
-------------------------------------------------------
Calendar Year Number of Issues Amount of Participation
- ------------- ---------------- -----------------------
Corporate Municipal Corporate Municipal
--------- --------- --------- ---------
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
2001 210 323 2,199,901,000 1,453,477,000
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, we could find it necessary to limit our
underwriting participations to remain in compliance with regulatory net capital
requirements. See "Net Capital Requirements."
Other Investment Banking Activities
Our investment banking activities also include debt and equity private
placements and advice with respect to merger and acquisition transactions, and
provision of financial advisory services to corporate and municipal clients.
At March 31, 2002, we had 95 professionals engaged in investment
banking activities, including 62 in corporate finance and 33 in municipal
finance.
Merchant Banking
Our subsidiary Legg Mason Merchant Banking, Inc. manages and sponsors
private equity funds. As of March 31, 2002, Legg Mason Merchant Banking, Inc.
managed Legg Mason Capital Partners, L.P., a private equity fund raised 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
Our Other businesses are principally our real estate service business
and unallocated corporate revenues and expenses. The real estate service
business is conducted through Legg Mason Real Estate Services, Inc. ("LMRES").
Real Estate Services
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, 2002 and 2001, the commercial mortgage servicing
portfolio of LMRES was $8.3 billion and $7.6 billion, respectively.
13
Research
Legg Mason Wood Walker employs 45 equity 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 their
underlying assets. Our equity research also focuses on companies in certain
business sectors, including companies in the following sectors:
. biotechnology;
. consumer services;
. financial services;
. industrial;
. real estate investment trust;
. technology; and
. telecommunications.
These research services are supplemented by research services purchased from
outside firms.
Our clients do not pay for research services directly,
although we are often compensated for our research services by institutional
clients through the direction of brokerage transactions to Legg Mason Wood
Walker for execution. We believe that our research activities are important in
attracting and retaining institutional and individual brokerage clients.
Administration
Our 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, 2002, we had approximately 270 full-time employees performing these
functions.
There is considerable fluctuation during any year and from
year to year in the volume of transactions we must process. We record
transactions and post our books on a daily basis. Our operations personnel
monitor day-to-day operations to determine compliance with applicable laws,
rules and regulations. Any failure to keep current and accurate books and
records can render Legg Mason Wood Walker 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.
We believe that our 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 financial services
industry. As required by the NYSE and certain other authorities, we carry a
fidelity bond covering loss or theft of securities, forgery of checks and drafts
and embezzlement and misplacement of securities.
Employees
At March 31, 2002, we had approximately 5,290 employees. None
of our employees is covered by a collective bargaining agreement. We consider
our relations with our employees to be satisfactory. However, competition for
experienced financial services personnel, especially financial advisors and
investment management professionals, is intense and from time to time we may
experience a loss of valuable personnel.
14
We recognize the importance to our private client business of
hiring and training financial advisors. We train 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 maintain ongoing training for
financial advisors.
Competition
We are engaged in an extremely competitive business. Our
competition includes, with respect to one or more aspects of our 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 we have.
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, we are competing directly with
these organizations. We also compete for investment funds with banks, insurance
companies and investment companies. The principal competitive factors relating
to our business are the quality of advice and services provided to investors and
the price of those services.
Competition in our business periodically has been affected by
significant developments in the financial services 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 conduct business. In addition,
financial services 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.
Our asset managers and sponsored mutual funds are subject to
extensive regulation. Our U.S. asset managers are registered as investment
advisers with the SEC and 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 that may be imposed for a failure include the suspension of
individual employees, limitations on the asset managers 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.
15
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.
Our 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 our broker-dealer subsidiaries was
required to pay the minimum annual assessment of $150 in fiscal 2002. 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. Legg
Mason Wood Walker 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
Legg Mason, Inc. is not itself a registered broker-dealer, it is not directly
subject to Rule 15c3-1. However, our 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, 2002, our broker-dealer subsidiaries had aggregate net capital of
$310.6 million, which exceeded the minimum net capital requirements by $289.4
million.
Under NYSE Rule 326, Legg Mason Wood Walker as a member
organization that carries customer accounts, would be required to reduce its
business activities if its net capital, as defined, was less than 4% of
aggregate debit items, as defined, and would be precluded from expanding its
business if its net capital was less than 5% of aggregate debit items. As of
March 31, 2002, Legg Mason Wood Walker's net capital was 29% of its aggregate
debit items.
Compliance with applicable net capital rules could limit the
operations of our 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 our broker-dealers to expand or
even maintain their present levels of business. See Note 16 of Notes to
Consolidated Financial Statements in Item 8 of this Report.
Legg Mason Wood Walker has in the past incurred subordinated
liabilities ("Subordinated Liabilities") to Legg Mason, Inc. which it was
permitted to treat as capital for the purposes of the Uniform Net Capital Rule
and NYSE Rules 325 and 326. During fiscal 2002, Legg Mason Wood Walker repaid
all outstanding Subordinated Liabilities.
16
Factors Affecting the Company and the Financial Services Industry
The financial services industry is characterized by frequent
changes, 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.
Importance of Investment Performance
We believe that investment performance is one of the most
important factors for the growth of assets under management for a company like
us 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
. our ability to attract funds from existing and new clients
might diminish.
If our revenues decline without a commensurate reduction in our expenses, our
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 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 redemptions
could 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, broad trends in
business and finance, and interest rate movements. Reduced volume and prices
generally result in lower brokerage and investment banking revenues, trading
losses as both principal and underwriter, 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
cycles 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 is 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
17
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;
. 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; or
. decreasing the performance fees earned by our asset management
subsidiaries.
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 businesses we are engaged in are
extremely competitive. Competition includes numerous national, regional and
local asset management firms and broker-dealers, and commercial bank and thrift
institutions. Many of these organizations have substantially more personnel and
greater financial resources than we do. 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. We also compete
for investment funds with banks, insurance companies and investment companies.
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 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 or
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. Our private client business may be adversely affected by the demand
for and availability of on-line securities trading.
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
18
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 in the
event acquired intangible assets become impaired;
. 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 and
performance fees. 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."
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."
Importance of Key Personnel
We are dependent on the continued services of our management
team, including our Chief Executive Officer, and a number of our key asset
management and securities personnel. The loss of such personnel without adequate
replacement could have a material adverse effect on us. Additionally, we need
qualified managers and skilled employees with financial services experience in
order to operate our business successfully. If we are unable to attract and
retain qualified individuals or our costs to do so increase significantly, our
operations would be materially adversely affected.
19
Operational Risks
There is considerable fluctuation during any year and from
year-to-year in the volume of transactions we must process. We record
transactions and post our books on a daily basis. Operations personnel monitor
day-to-day operations to determine compliance with applicable laws, rules and
regulations. Failure to keep current and accurate books and records can render
us liable to disciplinary action by governmental and self-regulatory
authorities, as well as to claims by our clients.
We depend on our headquarters and operations center for the continued
operation of our business. A disaster directly affecting our headquarters or
operations center may have a material adverse impact on our ability to continue
to operate our business without interruption. Although we have disaster recovery
programs in place, there can be no assurance that these will be sufficient to
mitigate the harm that may result from such a disaster. In addition, insurance
and other safeguards might only partially reimburse us for our losses.
International Operations
A number of our subsidiaries operate in Canada and the United Kingdom
on behalf of Canadian and UK clients. We also have offices in Spain, Singapore
and Switzerland. 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.
We lease all of our office space. Our headquarters, Baltimore
sales office and other functions are located in an office building in which we
are the major tenant. In that building, we currently occupy 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.
Our brokerage operations and technology functions are housed
in a separate office building in which we are 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 Legg Mason's retail
sales offices is contained in Item 1 of this Report. See Note 9 of Notes to
Consolidated Financial Statements in Item 8 of this Report for a discussion of
our lease obligations.
Item 3. Legal Proceedings.
Our subsidiaries are the subject of customer complaints, 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. These proceedings arise
primarily from securities brokerage, asset management and investment banking
activities. Some of these proceedings relate to public offerings of securities
in which one or more of our subsidiaries participated as a member of the
underwriting syndicate. We are also aware of litigation against certain
underwriters of offerings in which one or more of our subsidiaries was a
20
participant, but where the subsidiary is not now a defendant. In these latter
cases, it is possible that a subsidiary may be called upon to contribute to
settlements or judgments. While the ultimate resolution of pending litigation
and other matters cannot be currently determined, in the opinion of our
management, after consultation with legal counsel, these actions are expected to
be resolved with no material adverse effect on our financial condition. However,
if during any period a potential adverse contingency should become probable or
resolved, the results of operations in that period could be materially affected.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
Item 4A. Executive Officers of the Company.
Information (not included in our definitive proxy statement
for the 2002 Annual Meeting of Stockholders) regarding certain of our executive
officers is as follows:
Peter L. Bain, age 43, was elected Executive Vice President of
Legg Mason in July 2001, and was named head of our wealth management investment
advisory group 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 our wealth management
investment advisory subsidiaries and for ongoing acquisition strategy in the
wealth management market sector.
F. Barry Bilson, age 48, was elected Senior Vice President
of Legg Mason in October 1998. Mr. Bilson was Vice President-Finance of Legg
Mason from June 1984 through October 1998. Mr. Bilson has served in various
financial management capacities since joining us in 1981, and presently has
responsibility for business development projects. Mr. Bilson is a certified
public accountant.
Charles J. Daley, Jr., age 40, became Senior Vice President
and Treasurer of Legg Mason in January 2002 and Senior Vice President, Chief
Financial Officer and Treasurer of Legg Mason Wood Walker in December 2001. He
had been Vice President of Legg Mason since July 1999 and of Legg Mason Wood
Walker since 1997. From September 1988 through September 1997, he served as
Assistant Controller of Legg Mason and of Legg Mason Wood Walker. Mr. Daley is a
certified public accountant.
Mark R. Fetting, age 47, was elected Executive Vice
President of Legg Mason in July 2001. From June 2000 until July 2001, he served
as a Senior Advisor to Legg Mason. From 1991 to 2000, Mr. Fetting was Division
President and Senior Officer to Prudential Financial Group, Inc., a financial
services company. Mr. Fetting has responsibility for our mutual funds business.
Mr. Fetting is a director of 4 funds within the Legg Mason mutual funds complex
and 17 funds within the Royce & Associates mutual funds complex.
Thomas P. Mulroy, age 41, was elected Senior Vice President of
Legg Mason 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 August 1998. From 1986 through 1998, Mr. Mulroy held various positions
in Legg Mason Wood Walker's equity capital markets operations. Mr. Mulroy has
responsibility for Legg Mason Wood Walker's equity capital markets operations.
Robert F. Price, age 54, became Secretary of Legg Mason in
July 2000 and of Legg Mason Wood Walker in November 2000, and has been Senior
Vice President and General Counsel of Legg Mason 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.
21
Robert G. Sabelhaus, age 54, was elected Executive Vice
President of Legg Mason in July 2001 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.
Timothy C. Scheve, age 44, became a Senior Executive Vice
resident of Legg Mason in July 2000 and of Legg Mason Wood Walker in November
2000. He had been Executive Vice President of Legg Mason and of Legg Mason Wood
Walker since January 1998 Mr. Scheve has served in various financial and
administrative capacities since joining us in 1984, and presently has primary
responsibility for our administrative functions.
Elisabeth N. Spector, age 54, became a Senior Vice President
of Legg Mason in January 1994. She has general responsibilities in business
strategy.
Joseph A. Sullivan, age 44, became a Senior Vice President of
Legg Mason 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 former member of the Board of Directors of the Bond Market
Association.
Edward A. Taber, III, age 58, became a Senior Executive
Vice President of Legg Mason in July 1995. He has overall responsibility for our
institutional investment management activities. Mr. Taber is a director of the
Western Asset Funds, Inc., a mutual fund consisting of six portfolios.
22
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, 2002, there were
2,008 holders of record of Legg Mason's common stock. Information with respect
to our dividends and stock prices is as follows:
Quarter ended
- ------------------------------------------------------------------------------------------------------
Mar. 31 Dec. 31 Sept. 30 June 30
- ------------------------------------------------------------------------------------------------------
Fiscal 2002
Cash dividend per share $ 0.10 $ 0.10 $ 0.10 $ 0.09
Stock price range:
High 57.10 50.80 50.93 51.50
Low 48.36 38.35 34.25 38.06
Fiscal 2001
Cash dividend per share(1) $ 0.09 $ 0.09 $ 0.09 $ 0.08
Stock price range:
High 56.99 59.63 60.25 52.38
Low 40.15 42.88 47.63 35.13
_________________________
/(1)/ Excluding $.16 per share declared by Perigee Inc. prior to being acquired
in the quarter ended June 30, 2000.
Equity Compensation Plan Information
The following table provides information about our equity
compensation plans as of March 31, 2002.
- ----------------------------------------------------------------------------------------------------------------------
(a) (b) (c)
- ----------------------------------------------------------------------------------------------------------------------
Plan category Number of securities to Weighted-average Number of securities
be issued upon exercise exercise price of remaining available for
of outstanding options, outstanding options, future issuance under
warrants and rights warrants and rights equity compensation plans
(excluding securities
reflected in column (a))
- ----------------------------------------------------------------------------------------------------------------------
Equity compensation plans approved 11,285,130(1) $ 37.55(2) 6,193,828(3) (4)
by stockholders
- ----------------------------------------------------------------------------------------------------------------------
Equity compensation plans not 1,219,075(5) --(6) --(7)
approved by stockholders
- ----------------------------------------------------------------------------------------------------------------------
Total 12,504,205(1)(5) $ 37.55(2)(6) 6,193,828(3)(7)
- ----------------------------------------------------------------------------------------------------------------------
(1) Includes 1,879,425 shares of Legg Mason Common Stock ("Common Stock")
that are currently held in a trust pending distribution of phantom
stock units. The phantom stock units, which are converted into shares
of Common Stock on a one-for-one basis upon distribution, were granted
to plan participants upon their deferral of compensation or dividends
paid on phantom stock units. When amounts are deferred, participants
receive a number of phantom stock units equal to the deferred amount
divided by 90% to 100% of the fair market value of a share of Common
Stock.
23
(2) Does not include phantom stock units that are converted into Common
Stock on a one-for-one basis upon distribution at no additional cost,
but were acquired as described in footnote (1).
(3) In addition, an unlimited number of shares of Common Stock may be
issued under the Legg Mason Wood Walker, Incorporated Deferred
Compensation/Phantom Stock Plan upon the distribution of phantom stock
units that may be acquired in the future as described in footnote (1).
(4) 2,682,970 of these shares may be issued under our omnibus equity plan
as stock options, restricted or unrestricted stock grants or any other
form of equity compensation. 2,945,446 of these shares may be purchased
under our employee stock purchase plan, which acquires the shares that
are purchased thereunder in the open market.
(5) Includes 1,164,988 shares of Common Stock that are currently held in a
trust pending distribution of phantom stock units. The phantom stock
units, which are converted into shares of Common Stock on a
one-for-one basis upon distribution, were granted to plan participants
upon their deferral of compensation or dividends paid on phantom stock
units. When amounts are deferred, participants receive a number of
phantom stock units equal to the deferred amount divided by the fair
market value, or 95% of the fair market value, of a share of Common
Stock. Also includes 54,087 shares of Common Stock issuable under the
Howard Weil Plan (as defined below).
(6) Phantom stock units are converted into Common Stock on a one-for-one
basis upon distribution at no additional cost, but were acquired as
described in footnote (5). The Howard Weil Plan provides for the
issuance of shares of Common Stock upon the occurrence of certain
events at no additional cost to the recipient, however, these rights
were acquired upon the recipients' deferral of compensation or
dividends on rights held with a value equal to the market value of the
shares acquirable under the plan.
(7) There is an unlimited number of shares of Common Stock that may be
issued under the phantom stock plans described below upon distribution
of phantom stock units that may be acquired in the future as described
in footnote (5). Under the Howard Weil Plan, 54,087 shares of Common
Stock are currently held in a trust to be issued under the plan,
however, dividends on these shares are reinvested in the right to
receive additional shares of Common Stock which are purchased in the
market to fulfill this obligation.
Set forth below is a brief description of the material terms
of our equity compensation plans that have not been approved by our
stockholders. For all of our phantom stock plans described below, we issue to a
trust shares of our Common Stock that are available for distribution under the
plans.
Legg Mason Wood Walker, Incorporated Private Client Group Deferred Compensation
Plan ("PCG Plan")
Under the PCG Plan, financial advisors in our Private Client
Group are eligible to earn deferred bonuses in each calendar year based upon
several performance measures. Deferred bonuses under the PCG Plan may be deemed
invested in either an interest account or a "phantom stock" account. Amounts
deemed invested in phantom stock accounts are credited as a number of phantom
stock units based on a unit price equal to the market price for a share of Legg
Mason Common Stock. The number of phantom stock units credited to an account
will be adjusted over the deferral period to account for any stock dividends,
stock splits and similar events. Dividends paid on Common Stock are credited to
phantom stock accounts by adding a number of phantom stock units based on a unit
price equal to 95% of the market price for a share of Common Stock. Amounts
deemed invested in interest accounts are annually credited with interest.
Deferred bonuses under the PCG Plan vest at the end of the sixth calendar year
after they are credited, and are subject to forfeiture if the recipient's
employment with us terminates prior to the vesting date, other than a
termination as a result of death, disability or retirement. Vested deferred
bonuses are distributed to the recipient, at the election of the recipient, upon
either (i) the date they vest or (ii) the date the recipient's employment with
us terminates. Upon a distribution, the participant receives (in a lump sum or
in periodic installments, at the participant's election) a number of shares of
Common Stock equal to the number of
24
phantom stock units that are to be distributed, or cash in the amount of
the balance of the interest account.
In 2002, the PCG Plan was replaced with the Legg Mason Wood
Walker, Incorporated Financial Advisor Deferred Compensation Plan (the "FA
Plan"). All future deferred bonuses will be awarded under the FA Plan, however
the PCG Plan continues to apply to deferred bonuses for prior years. The FA Plan
is substantially similar to the PCG Plan, except that all distributions are made
in a lump sum at the time the deferred bonuses vest.
Legg Mason Wood Walker, Incorporated Key Employee Phantom Stock Agreements (the
"Key Employee Agreements")
Under the Key Employee Agreements, certain employees, as part
of their recruitment by our Private Client Group, are offered deferred
compensation bonuses credited within the first year of their employment.
Deferral amounts under the Key Employee Agreements are deemed invested in
"phantom stock" units based on a unit price equal to the market price for a
share of Legg Mason Common Stock. The number of phantom stock units credited to
an account will be adjusted over the deferral period to account for any stock
dividends, stock splits and similar events. Dividends paid on Common Stock are
credited to phantom stock accounts by adding a number of phantom stock units
based on a unit price equal to 95% of the market price for a share of Common
Stock. A portion of the deferred amounts under the Key Employee Agreements vest
each year over a period of five years, and are subject to forfeiture if the
recipient's employment with us terminates prior to the vesting date, other than
a termination as a result of death or disability. Vested deferred amounts are
distributed to the recipient, at the election of the recipient, upon one of (i)
the date they vest, (ii) the date the entire deferred amount vests, or (iii) the
date the recipient's employment with us terminates. Upon a distribution, the
participant receives (in a lump sum or in periodic installments, at the
participant's election) a number of shares of Common Stock equal to the number
of phantom stock units that are to be distributed.
Legg Mason Wood Walker, Incorporated Professional Branch Manager Phantom Stock
Agreements (the "Branch Manager Plan")
Under the Branch Manager Plan, certain of the branch managers
in our Private Client Group may elect to defer up to $12,000 of compensation in
any calendar year. We "match" dollar-for-dollar all amounts deferred under the
Branch Manager Plan. Deferred and match amounts under the Branch Manager Plan
are deemed invested in "phantom stock" units based on a unit price equal to the
market price for a share of Common Stock. The number of phantom stock units
credited to an account will be adjusted over the deferral period to account for
any stock dividends, stock splits and similar events. Dividends paid on Common
Stock are credited to phantom stock accounts by adding a number of phantom stock
units based on a unit price equal to 95% of the market price for a share of
Common Stock. Phantom stock units resulting from the Legg Mason "match" vest six
full years after they are credited, and are subject to forfeiture if the
recipient's employment with us terminates prior to the vesting date, other than
a termination as a result of death, disability or retirement. Vested deferred
amounts are distributed to the recipient, at the election of the recipient, upon
either (i) the date they vest or (ii) the date the recipient's employment with
us terminates. In a distribution, the participant receives (in a lump sum or in
periodic installments, at the participant's election) a number of shares of
Common Stock equal to the number of phantom stock units that are to be
distributed.
Howard, Weil, Labouisse, Friedrichs, Inc. Equity Incentive Plan (the "Howard
Weil Plan")
Under the Howard Weil Plan, certain employees of Howard, Weil,
Labouisee, Friedrichs, Inc. ("Howard Weil") were entitled to defer their receipt
of compensation. The deferred amounts were deemed invested in Voting Stock of
Howard Weil. When we acquired Howard Weil in 1987, the deferred amounts were
funded by placing Howard Weil stock into a trust, and the stock in the trust was
converted into Legg Mason Common Stock. Since the acquisition, no additional
amounts have been deferred under the Howard Weil Plan. However, the Howard Weil
plan governs the distribution of shares from the trust to participants. In
addition, dividends paid on the shares held in the trust are used to purchase
additional shares of Legg Mason Common Stock in the open market, which are then
credited to the accounts of participants.
25
Item 6. Selected Financial Data.
(Dollars in thousands except per share amounts)
Years ended March 31,
2002 2001 2000 1999 1998
- ---------------------------------------------------------------------------------------------------------------------------
Operating Results
Total revenues $ 1,578,612 $ 1,536,253 $ 1,399,585 $ 1,070,670 $ 909,306
Interest expense 127,271 175,389 134,382 94,974 73,776
- ---------------------------------------------------------------------------------------------------------------------------
Net revenues 1,451,341 1,360,864 1,265,203 975,696 835,530
Non-interest expenses 1,198,092 1,095,044 1,010,765 818,885 707,965
- ---------------------------------------------------------------------------------------------------------------------------
Earnings before income tax provision 253,249 265,820 254,438 156,811 127,565
Income tax provision 100,313 109,590 104,025 63,537 52,258
- ---------------------------------------------------------------------------------------------------------------------------
Net earnings $ 152,936 $ 156,230 $ 150,413 $ 93,274 $ 75,307
- ---------------------------------------------------------------------------------------------------------------------------
Per Common Share/(1)/
Earnings per share:
Basic $ 2.35 $ 2.45 $ 2.43 $ 1.57 $ 1.26
Diluted 2.24 2.30 2.27 1.48 1.19
Weighted average shares outstanding (in thousands):
Basic 65,211 63,793 61,868 59,516 59,611
Diluted 68,262 67,916 65,967 62,836 63,187
Dividends declared/(2)/ $ .390 $ .350 $ .305 $ .250 $ .214
Book value 16.20 14.14 12.09 9.51 8.48
- ---------------------------------------------------------------------------------------------------------------------------
Financial Condition
Total assets $ 5,939,614 $ 4,687,626 $ 4,812,107 $ 3,500,202 $2,856,389
Long-term debt 779,463 99,770 99,723 99,676 99,628
Notes payable of finance subsidiaries/(3)/ 97,659 119,200 239,268 -- --
Stockholders' equity 1,084,548 927,720 770,808 571,969 510,808
- ---------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------
/(1)/ Adjusted to reflect all stock splits.
/(2)/ Excluding $.16, $.60 and $.19 per share declared by Perigee Inc. prior to
acquisition in 2001, 2000 and 1999, respectively.
/(3)/ Non-recourse, secured fixed-rate notes of Legg Mason Investors' finance
subsidiaries, the proceeds of which are invested in financial instruments
with similar maturities. See Notes 2 and 8 of Notes to Consolidated
Financial Statements.
26
Item 7. Management's Discussion and Analysis of Results of Operations and
Financial Condition.
Business Description
Legg Mason, Inc. (the "Parent"), a holding company, and its subsidiaries
(collectively with the Parent, "Legg Mason") are principally engaged in
providing asset management, securities brokerage, investment banking and related
financial services to individuals, institutions, corporations and
municipalities. Terms such as "we," "us," "our" and "company" refer to Legg
Mason.
Legg Mason has operations principally in the United States of America, the
United Kingdom and Canada and also has offices in Spain, Switzerland and
Singapore. The financial services industry in which Legg Mason operates is very
competitive and highly regulated. Our profitability is sensitive to a variety of
factors including the amount of our assets under management, the volume of
trading in securities, the volatility and general level of securities prices and
interest rates, the level of customer margin and credit account balances and the
demand for investment banking services. In addition, overall market conditions,
the diversification of services and products offered, investment performance and
client relations are significant factors in determining whether we are
successful in retaining and attracting clients. In the past decade, we have
experienced substantial expansion due to internal growth and the strategic
acquisition of asset management firms that provided, among other things, a
broader range of investment expertise, additional product diversification and
increased assets under management.
Legg Mason currently operates through four business segments: Asset
Management, Private Client, Capital Markets and Other. The business segments are
based upon factors such as the services provided and distribution channels
utilized. Certain services that we offer are provided to clients through more
than one of our business segments. As such, the same revenue category may be
reflected in multiple segments. We allocate certain common income and expense
items among our business segments based upon various methodologies and factors.
The Asset Management segment provides investment advisory services to
company-sponsored investment funds and asset management services to
institutional and individual clients. Investment advisory and related fees
earned by Asset Management vary based upon factors such as the type of
underlying investment product, the amount of assets under management and the
type of services that are provided. In addition, performance fees may be earned
on certain investment advisory contracts for exceeding performance benchmarks.
The Private Client segment distributes a wide range of financial products
through its branch distribution network, including equity and fixed income
securities, proprietary and non-affiliated mutual funds and annuities. At March
31, 2002, Private Client's financial advisors operated out of 134 retail branch
offices. The primary sources of net revenues for Private Client are commissions
and principal credits earned on equity and fixed income transactions in customer
brokerage accounts, distribution fees earned on mutual funds, fees earned on
fee-based brokerage and managed accounts and net interest from customers' margin
loan and credit account balances. Sales credits associated with underwritten
offerings initiated in the Capital Markets segment are reported in Private
Client when sold through its branch distribution network.
The Capital Markets segment consists of our equity and fixed income
institutional sales and trading and corporate and public finance advisory and
underwriting activities. Fixed income institutional sales and trading include
transactions in both taxable and municipal products. Although we maintain
securities in inventory primarily to facilitate customer transactions, Capital
Markets also realizes profits and losses from trading activities. Sales credits
associated with underwritten offerings are reported in Capital Markets when sold
through institutional distribution channels. The results of this business
segment also include realized and unrealized gains and losses on investments
acquired in connection with merchant banking and investment banking activities.
The Other segment consists principally of our real estate service business
and unallocated corporate revenues and expenses.
All references to fiscal 2002, 2001 or 2000 refer to our March 31 fiscal year
then ended.
27
Business Environment
For the U.S. economy, fiscal 2002 was a period of slower economic growth,
declines in corporate earnings and rising unemployment levels. During fiscal
2002, the equity markets continued to be volatile and weak, particularly in the
technology and telecommunications sectors. Corporate failures and the associated
accounting questions have also contributed to the negative market conditions and
low investor confidence. Finally, the events of the September 11 terrorist
attacks and the political unrest abroad have also contributed to the sluggish
economy. In an effort to stimulate the lagging economy, the U.S. Federal Reserve
significantly lowered the overnight interest rate 11 times or 6.5% over the last
15 months. Although we were not physically impacted by the events of September
11, its effect on the economy and investor confidence negatively impacted our
business and, in particular, our Private Client business. Despite the difficult
market conditions, we were able to achieve record net revenues primarily as a
result of the addition of fees from acquired entities and growth in fixed income
investment advisory accounts.
Results of Operations
Our financial position and results of operations are materially affected by the
overall trends and conditions of the financial markets, particularly in the
United States. Results of any individual period should not be considered
representative of future results. Many of our activities have fixed operating
costs that do not decline with reduced levels of business activity. Accordingly,
sustained periods of unfavorable market conditions are likely to affect our
profitability adversely.
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 a percentage of the amount for the previous
period:
Percentage of Net Revenues Period to Period Change
-------------------------------------------------------------------
Years ended March 31, 2002 2001
------------------------------------- Compared Compared
2002 2001 2000 to 2001 to 2000
- ---------------------------------------------------------------------------------------------------------------------------
Revenues
Investment advisory and related fees ........... 53.9% 48.1% 44.5% 19.5% 16.1%
Commissions .................................... 22.8 26.3 28.7 (7.7) (1.2)
Principal transactions ......................... 9.6 9.2 10.0 11.5 (1.4)
Investment banking ............................. 7.0 4.8 5.5 55.1 (4.4)
Interest ....................................... 11.6 20.7 17.6 (40.4) 26.5
Other .......................................... 3.9 3.8 4.3 11.6 (7.2)
----- ----- -----
Total revenues. .............................. 108.8 112.9 110.6 2.8 9.8
Interest expense ............................... 8.8 12.9 10.6 (27.4) 30.5
----- ----- -----
Net revenues ................................. 100.0 100.0 100.0 6.6 7.6
===== ===== =====
Non-Interest Expenses
Compensation and benefits ...................... 60.9 59.1 59.2 9.8 7.4
Communications and technology .................. 6.8 7.6 7.0 (3.7) 16.3
Occupancy ...................................... 4.3 3.8 3.8 20.4 7.3
Amortization of intangible assets .............. 1.3 0.9 0.9 51.8 13.1
Other .......................................... 9.3 9.1 9.0 9.1 8.2
----- ----- -----
Total non-interest expenses .................. 82.6 80.5 79.9 9.4 8.3
----- ----- -----
Earnings Before Income Tax Provision .............. 17.4 19.5 20.1 (4.7) 4.5
Income tax provision ........................... 6.9 8.0 8.2 (8.5) 5.3
----- ----- -----
Net Earnings ...................................... 10.5% 11.5% 11.9% (2.1) 3.9
===== ===== =====
- ---------------------------------------------------------------------------------------------------------------------------
28
Fiscal 2002 Compared with Fiscal 2001
Financial Overview
In fiscal 2002, net revenues reached record levels and increased 7% to $1.45
billion, primarily as a result of an increase in investment advisory and related
fees. On August 1, 2001, we acquired Private Capital Management, L.P. and its
affiliated entities ("PCM"), a high net worth investment manager in Naples,
Florida. At acquisition date, PCM managed $8.6 billion of assets, primarily in
small to mid-cap stocks. On October 1, 2001, we acquired Royce & Associates,
Inc. ("Royce"), an investment manager located in New York City. At acquisition
date, Royce managed $4.7 billion of assets, primarily in small and micro-cap
mutual funds. Both acquisitions were accounted for as purchase transactions.
Under purchase accounting, the net assets and results of operations of both PCM
and Royce are included in our financial statements from the respective dates of
their acquisition. Revenues from investment advisory and related activities
(including distribution fees from mutual funds) rose $127.6 million or 20% to
$781.6 million in fiscal 2002, primarily as a result of the acquisitions of PCM
and Royce, which contributed $97.1 million of the increase. The remainder of the
increase is primarily attributable to growth in assets under management in fixed
income advisory accounts.
Revenues from securities brokerage activities, including both commissions
and principal transactions, declined 3% to $469.8 million as a result of a
decrease in retail securities transactions and non-affiliated mutual fund and
variable annuity sales. These declines were offset in part by increases in fixed
income and equity institutional securities transaction volume. Revenues from
investment banking activities increased 55% to $102.2 million primarily due to a
$34.2 million increase in new issue sales concessions and increased municipal
banking fees. Other revenues increased 12% to $57.0 million primarily as a
result of realized and unrealized gains on firm investments and an increase in
loan origination fees, partially offset by the sale of a merchant banking
related investment in the prior fiscal year. Our net interest profit declined
62% to $40.8 million from $106.8 million in the prior fiscal year as a result of
lower average interest rates earned on firm investments, lower customer margin
account balances and an increase in acquisition-related debt