10-Q 1 r10q1201.txt SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarter Ended December 31, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to _______________ Commission file number 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 incorporation or organization) Identification No.) 100 Light Street - Baltimore, MD 21202 (Address of principal executive offices) (Zip code) (410) 539-0000 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 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 the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. 64,264,082 shares of common stock and 2,529,949 exchangeable shares as of the close of business on February 6,2002. The exchangeable shares, which were issued by Legg Mason Canada Holdings in connection with the acquisition of Perigee Inc., are exchangeable at any time into common stock on a one-for-one basis and entitle holders to dividend, voting and other rights equivalent to common stock. 2 PART I. FINANCIAL INFORMATION Item 1. Financial Statements
LEGG MASON, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (in thousands of dollars) December 31,2001 March 31, 2001 (Unaudited) ASSETS: Cash and cash equivalents................... $ 635,281 $ 556,148 Cash and securities segregated for regulatory purposes........................ 2,327,269 1,942,110 Securities purchased under agreements to resell.................................. 20,000 - Receivables: Customers.................................. 1,027,246 1,102,920 Brokers,dealers and clearing organizations. 158,090 108,560 Others..................................... 144,204 121,600 Securities borrowed......................... 343,316 247,229 Financial instruments owned, at fair value.. 173,145 127,188 Investment securities, at fair value........ 18,649 14,050 Investments of finance subsidiaries......... 99,119 115,226 Equipment and leasehold improvements, net... 69,955 71,645 Intangible assets, net...................... 512,362 61,748 Goodwill.................................... 429,003 87,701 Other....................................... 142,780 131,501 $6,100,419 $4,687,626 LIABILITIES AND STOCKHOLDERS' EQUITY: Liabilities: Payables: Customers................................. $3,371,704 $2,909,147 Brokers and dealers....................... 23,622 45,787 Securities loaned.......................... 300,228 252,925 Short-term borrowings...................... 100,367 4,900 Financial instruments sold, but not yet purchased, at fair value.................. 49,147 38,814 Accrued compensation....................... 167,169 146,279 Other...................................... 168,261 143,084 Notes payable of finance subsidiaries...... 98,888 119,200 Long-term debt............................. 777,668 99,770 5,057,054 3,759,906 Stockholders' Equity: Common stock............................... 6,408 6,285 Shares exchangeable into common stock...... 9,748 10,439 Additional paid-in capital................. 358,049 330,394 Deferred compensation and employee note receivable................................ (34,750) (36,406) Employee stock trust....................... (90,864) (81,225) Deferred compensation employee stock trust. 90,864 81,225 Retained earnings.......................... 712,233 624,665 Accumulated other comprehensive loss, net.. (8,323) (7,657) 1,043,365 927,720 $6,100,419 $4,687,626
See notes to consolidated financial statements. 3
LEGG MASON, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS (in thousands, except per share amounts) (Unaudited) Three months Nine months ended December, 31 ended December 31, 2001 2000 2001 2000 Revenues: Investment advisory and related fees $208,003 $165,564 $ 559,275 $ 487,660 Commissions......................... 80,861 92,705 243,606 273,550 Principal transactions.............. 37,856 30,038 102,309 91,271 Investment banking.................. 24,443 15,746 72,061 48,245 Interest............................ 33,496 73,343 137,082 217,117 Other............................... 19,146 16,260 43,424 38,399 Total revenues.................... 403,805 393,656 1,157,757 1,156,242 Interest expense.................... 29,039 44,571 101,601 134,123 Net revenues...................... 374,766 349,085 1,056,156 1,022,119 Non-Interest Expenses: Compensation and benefits........... 226,470 205,993 642,705 603,540 Communications and technology....... 24,187 26,618 75,328 75,882 Occupancy........................... 15,232 12,879 46,219 38,344 Amortization of intangibles......... 6,258 2,917 12,602 8,962 Other............................... 35,615 30,927 101,977 93,873 Total non-interest expenses........ 307,762 279,334 878,831 820,601 Earnings Before Income Tax Provision. 67,004 69,751 177,325 201,518 Income tax provision................ 25,916 28,430 70,486 82,607 Net Earnings ........................ $ 41,088 $ 41,321 $ 106,839 $ 118,911 Earnings per common share: Basic............................... $ 0.63 $ 0.65 $ 1.64 $ 1.87 Diluted............................. $ 0.60 $ 0.61 $ 1.57 $ 1.75 Weighted average number of common shares outstanding: Basic.............................. 65,399 64,010 65,075 63,660 Diluted............................ 68,198 68,134 68,093 67,874 Dividends declared per common share.. $ 0.10 $ 0.09 $ 0.29 $ 0.26 Book value per common share.......... $ 15.65 $ 13.77
See notes to consolidated financial statements. 4
LEGG MASON, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands of dollars) (Unaudited) Nine months ended December 31, 2001 2000 CASH FLOWS FROM OPERATING ACTIVITIES: Net earnings........................................ $106,839 $118,911 Non-cash items included in earnings: Depreciation and amortization..................... 32,448 27,166 Originated mortgage servicing rights.............. (1,602) (1,519) Deferred compensation............................. 6,300 3,602 Unrealized gains/losses on firm investments....... (2,282) 3,044 Other............................................. 6,978 2,575 Deferred income taxes.............................. 12,056 (5,656) (Increase) decrease in assets excluding business acquisitions: Cash and securities segregated for regulatory purposes.......................................... (385,159) (315,134) Receivable from customers.......................... 75,674 185,151 Other receivables.................................. (45,867) (68,830) Securities borrowed................................ (96,087) 417,947 Financial instruments owned........................ (45,957) (8,848) Other.............................................. (9,517) (30,212) Increase (decrease) in liabilities excluding business acquisitions: Payable to customers............................... 462,557 257,262 Payable to brokers and dealers..................... (22,165) (4,206) Securities loaned.................................. 47,303 (436,712) Financial instruments sold, but not yet purchased.. 10,333 32,174 Accrued compensation............................... (6,227) (86) Other.............................................. 7,954 5,211 CASH PROVIDED BY OPERATING ACTIVITIES................ 153,579 181,840 CASH FLOWS FROM INVESTING ACTIVITIES: Payments for: Equipment and leasehold improvements.............. (14,973) (22,261) Asset management and mortgage servicing contracts. (2,658) (2,227) Business acquisitions, net of cash acquired....... (794,522) - Net increase in securities purchased under agreements to resell......................... (20,000) (233,673) Purchases of investment securities.................. (8,649) (9,285) Proceeds from sales and maturities of investment securities........................................ 33,004 102,862 CASH USED FOR INVESTING ACTIVITIES................... (807,798) (164,584) CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in short-term borrowings............... 95,467 138,120 Issuance of long-term debt.......................... 664,554 - Repayment of notes payable of finance subsidiaries.. (26,676) (91,795) Issuance of common stock............................ 16,983 17,627 Dividends paid...................................... (18,481) (18,939) CASH PROVIDED BY FINANCING ACTIVITIES................ 731,847 45,013 EFFECT OF EXCHANGE RATE CHANGES ON CASH.............. 1,505 (321) NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS. 79,133 61,948 CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD..... 556,148 213,203 CASH AND CASH EQUIVALENTS AT END OF PERIOD........... $635,281 $275,151
See notes to consolidated financial statements. 5
LEGG MASON, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (in thousands of dollars) (Unaudited) Three months ended Nine months ended December 31, December 31, 2001 2000 2001 2000 Net earnings........................... $41,088 $41,321 $106,839 $118,911 Other comprehensive income: Foreign currency translation adjustments......................... (822) (268) 1,392 (479) Unrealized gains(losses)on investment securities: Unrealized holding gains (losses) arising during the period......... (3,003) 419 (2,353) 2,022 Reclassification adjustment for losses(gains) included in net income............................ (680) 39 (840) 39 Net unrealized gains (losses)...... (3,683) 458 (3,193) 2,061 Deferred income taxes................. 1,371 229 1,135 (141) Total other comprehensive income..... (3,134) 419 (666) 1,441 Comprehensive income................... $37,954 $41,740 $106,173 $120,352
See notes to consolidated financial statements. 6 LEGG MASON, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except per share amounts) December 31, 2001 (Unaudited) 1. Interim Basis of Reporting: The accompanying unaudited consolidated financial statements of Legg Mason, Inc. and its subsidiaries (the "Company") have been prepared in accordance with generally accepted accounting principles for interim financial information. The interim financial statements have been prepared utilizing the interim basis of reporting and, as such, reflect all adjustments (consisting only of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the results for the periods presented. The nature of the Company's business is such that the results of any interim period are not necessarily indicative of results for a full year. The information contained in the interim financial statements should be read in conjunction with the Company's latest Annual Report on Form 10-K filed with the Securities and Exchange Commission. Where appropriate, prior years' financial statements have been reclassified to conform with the current year's presentation. Unless otherwise noted, all per share amounts include both common shares of the Company and shares issued in connection with the acquisition of Perigee Inc., which are exchangeable into common shares of the Company on a one-for-one basis at any time. 2. Net Capital Requirements: The Company's broker-dealer subsidiaries are subject to the Securities and Exchange Commission's Uniform Net Capital Rule. The Rule provides that equity capital may not be withdrawn or cash dividends paid if resulting net capital would fall below specified levels. As of December 31, 2001, the broker-dealer subsidiaries had aggregate net capital, as defined, of $294,461 which exceeded required net capital by $274,064. 3. Financial Instruments Owned, at Fair Value: At December 31, 2001, the Company had pledged $211 of securities as collateral to counterparties for securities loaned transactions and for commodities clearing requirements, which can be sold or repledged by the counterparties. 7 4. Long-Term Debt: The Company's long-term debt at December 31, 2001 consists of $423,938 of 6.75% senior notes, $253,924 of zero-coupon convertible senior notes, and $99,806 of 6.50% senior notes. On July 2, 2001, the Company issued $425,000 principal amount of senior notes due July 2, 2008, which bear interest at 6.75%. The notes were sold at a discount to yield 6.80%. A portion of the approximately $421,000 proceeds from the notes was used to fund the purchase of Private Capital Management, L.P.("PCM"). Additionally, a portion of these proceeds was used to fund the purchase of Royce & Associates, Inc. ("Royce")(see Note 8). On June 6, 2001 the Company issued $567,000 principal amount at maturity of zero-coupon convertible senior notes due on June 6, 2031, resulting in gross proceeds of approximately $250,000. The convertible notes were issued in a private placement to qualified institutional buyers at an initial offering price of $440.70 per $1,000 principal amount at maturity. The discounted price reflects a yield to maturity of 2.75% per year. Upon certain events, including the sale price of the Company's common stock reaching certain thresholds, the convertible notes being rated below specified credit ratings and the convertible notes being called for redemption, each note is convertible into 7.7062 shares of the Company's common stock, subject to adjustment. The Company may redeem the convertible notes for cash on or after June 6, 2006 at their accreted value. In addition, the Company may be required to repurchase the convertible notes at their accreted value, at the option of the holders, on various dates beginning on June 6, 2003, or upon a change of control of the Company. Such repurchases can be paid in cash, shares of the Company's common stock or a combination of both. The net proceeds of the offering were $244,375, after payment of debt issuance costs. The debt issuance costs are included in other assets and are being amortized over a two-year period up to the date of the first repurchase option of the holders. Approximately 4.4 million shares of common stock are reserved for issuance upon conversion. The Company also has outstanding $100,000 of senior notes due February 15, 2006, which bear interest at 6.50%. The notes were issued at a discount to yield 6.57%. 8 5. Earnings Per Share: The following tables present the computations of basic and diluted earnings per share for the three and nine months ended December 31, 2001 and 2000.
Three months ended December 31, 2001 2000 Basic Diluted Basic Diluted Weighted average shares outstanding: Common stock 65,399 65,399 64,010 64,010 Stock options - 2,309 - 3,587 Shares related to deferred compensation - 490 - 537 Weighted average common and common equivalent shares outstanding 65,399 68,198 64,010 68,134 Net earnings applicable to common stock $41,088 $41,088 $41,321 $41,321 Earnings per common share $ 0.63 $ 0.60 $ 0.65 $ 0.61
Nine months ended December 31, 2001 2000 Basic Diluted Basic Diluted Weighted average shares outstanding: Common stock 65,075 65,075 63,660 63,660 Stock options - 2,522 - 3,693 Shares related to deferred compensation - 496 - 521 Weighted average common and common equivalent shares outstanding 65,075 68,093 63,660 67,874 Net earnings applicable to common stock $106,839 $106,839 $118,911 $118,911 Earnings per common share $ 1.64 $ 1.57 $ 1.87 $ 1.75
9 6. Accounting Developments: The results for the quarter and nine months ended December 31, 2001 include the effect of adopting Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets", which resulted in expense reductions of $1,898 ($1,637 net of tax) for the quarter and $5,776 ($4,992 net of tax) for the nine months. These expense reductions increased basic and diluted earnings per share by $0.03 and $0.02 respectively, for the quarter and $0.08 and $0.07, respectively, for the nine months ended December 31, 2001. SFAS No. 141 provides that all business combinations initiated after June 30, 2001 shall be accounted for using the purchase method. In addition, it provides that the cost of an acquired entity must be allocated to the assets acquired, including identifiable intangible assets, and liabilities assumed based on their estimated fair values at the date of acquisition. The excess cost over the fair value of the net assets acquired must be recognized as goodwill. SFAS No. 142 provides that goodwill is no longer amortized and the value of an identifiable intangible asset must be amortized over its useful life, unless the asset is determined to have an indefinite useful life. Goodwill must be tested for impairment as of the beginning of the fiscal year in which SFAS No. 142 is adopted. The Company has completed its testing of goodwill and has determined that there is no impairment as of April 1, 2001. The $1,898 and $5,776 pre-tax reduction of intangible amortization expense for the quarter and nine months, respectively, represents the amount of amortization of goodwill and indefinite-life intangible assets that arose from acquisitions prior to June 30, 2001 and are no longer amortized. Amounts assigned to indefinite-life intangible assets primarily represent the value of contracts to manage assets in mutual funds and similar pooled investment products, which are deemed to have indeterminable lives. 10 The following table reflects consolidated results adjusted as though the adoption of SFAS Nos. 141 and 142 occurred as of the beginning of the three and nine month periods ended December 31, 2000:
Three months Nine months ended December 31, ended December, 31 2001 2000 2001 2000 Net Earnings: As reported $ 41,088 $ 41,321 $106,839 $118,911 Goodwill amortization - 1,154 - 3,524 Indefinite-life intangibles amortization - 256 - 788 As adjusted $ 41,088 $ 42,731 $106,839 $123,223 Basic Earnings Per Share: As reported $ 0.63 $ 0.65 $ 1.64 $ 1.87 Goodwill amortization - 0.02 - 0.06 Indefinite-life intangibles amortization - - - 0.01 As adjusted $ 0.63 $ 0.67 $ 1.64 $ 1.94 Diluted Earnings Per Share: As reported $ 0.60 $ 0.61 $ 1.57 $ 1.75 Goodwill amortization - 0.02 - 0.05 Indefinite-life intangibles amortization - - - 0.02 As adjusted $ 0.60 $ 0.63 $ 1.57 $ 1.82
The following table reflects the components of intangible assets as of December 31, 2001: Gross Carrying Accumulated Amount Amortization Amortized intangible assets: Asset management contracts $362,999 $ 24,080 Mortgage servicing contracts 10,898 4,650 Total amortized intangible assets $373,897 $ 28,730 Non-amortized intangible assets: Fund management contracts $112,495 $ - Trade name 54,700 - Total non-amortized intangible assets $167,195 $ - During the quarter, the Company recorded an impairment charge of $1,200, representing the fair value of asset management contracts, acquired in a business combination, that were terminated during the period. 11 Estimated amortization expense for each of the five succeeding fiscal years is as follows: Fiscal year ended March 31: Amount 2002 $18,615 2003 24,350 2004 23,267 2005 22,985 2006 22,678 The Company's carrying value of goodwill of approximately $429,003 at December 31, 2001 is primarily attributable to its asset management reporting segment. The increase in the carrying value of goodwill since March 31, 2001 reflects the acquisition of PCM and its affiliated entities, the acquisition of Royce and the acquisition of the assets of a Pennsylvania-based investment advisor, which was not material to the Company's financial statements, and the impact of changes in foreign currency exchange rates. 7. Legal Proceedings: The Company has been the subject of customer complaints and has also been named as a defendant in various legal actions arising primarily from securities brokerage, asset management and investment banking activities, including certain class actions which primarily allege violations of securities laws and seek unspecified damages which could be substantial, and has been involved in certain governmental and self regulatory agency investigations and proceedings. While the ultimate resolution of these actions cannot be currently determined, in the opinion of management, after consultation with legal counsel, the actions are expected to be resolved with no material adverse effect on the Company's financial position. However, if during any period a potential adverse contingency should become probable, the results of operations in that period could be materially affected. During the quarter and nine months ended December 31, 2001, the Company recorded charges for litigation of $4.5 million and $12.0 million, respectively, net of an insurance reimbursement of $5.0 million related to settlements prior to the quarter. 8. Acquisitions: On October 1, 2001, the Company completed the acquisition of Royce, which manages small-cap and micro-cap mutual funds. At the date of acquisition, Royce managed assets of approximately $4.7 billion. The Company acquired Royce for an initial cash payment of $115,000 plus acquisition costs of $800. In accordance with SFAS No. 141, the acquisition was accounted for as a purchase. The acquisition of Royce fits the Company's strategic objective to grow its asset management business. The determination of the purchase price was made on the basis of, among other things, the revenues, profitability and growth rates of Royce. 12 A summary of the fair values of the net assets acquired is as follows: Current assets, net $ 3,121 Fixed assets 1,272 Trade name 7,700 Asset management contracts 5,200 Mutual fund contracts 99,200 Fair value of net assets acquired $ 116,493 The fair value of the asset management contracts of $5,200 is being amortized over an average life of seven years. The value of the trade name and mutual fund contracts are not subject to amortization. The fair value of net assets acquired exceeds the purchase price of $115,800 (including acquisition costs of $800) by $693. In accordance with SFAS No. 141, this excess is recognized as a liability until the contingent payments are settled. The transaction also includes three contingent payments based on a multiple of Royce's revenue for the years ending on the third, fourth and fifth anniversaries of closing, with the aggregate purchase price to be no more than $215,000. The Company has the option to pay as much as 50% of the remaining purchase price in common stock. On August 1, 2001, the Company completed the acquisition of PCM and its affiliated entities for cash of approximately $682,000 plus acquisition costs of $1,000. In accordance with SFAS No. 141, the acquisition was accounted for as a purchase. PCM, a leading high net worth investment manager, managed assets of approximately $8.6 billion at the date of acquisition. The acquisition of PCM fits the Company's strategic objective to grow its asset management business. The determination of the purchase price was made on the basis of, among other things, the revenues, profitability and growth rates of PCM. A summary of the fair values of the net assets acquired is as follows: Current assets, net $ 4,228 Fixed assets 1,903 Trade name 47,000 Asset management contracts 298,000 Goodwill 331,869 Total purchase price, including acquisition costs $ 683,000 The fair value of the asset management contracts of $298,000 are being amortized over an average life of eighteen years. The value of the trade name is not subject to amortization. 13 The total amount of goodwill is deductible for tax purposes and is attributable to the asset management segment. The transaction also includes two contingent payments, after the third and fifth anniversaries of closing, based on PCM's revenue growth, with the aggregate purchase price to be no more than $1.382 billion. Any additional payments required as a result of the contingency will be allocated to goodwill. The following unaudited pro-forma consolidated results are presented as though the acquisitions of PCM and Royce and their affiliated entities had occurred as of the beginning of each period presented. Three months ended Nine months ended December 31, December 31, 2000 2001 2000 Net Revenues $364,835 $1,103,142 $1,066,822 Net Earnings $ 42,191 $ 116,899 $ 121,255 Earnings per common share: Basic $ 0.66 $ 1.80 $ 1.90 Diluted $ 0.62 $ 1.72 $ 1.79 9. Business Segment Information: The Company provides financial services through four business segments: Asset Management; Private Client; Capital Markets; and Other. Business segment results include all direct revenues and expenses of the operating units in each business segment and allocations of indirect expenses based on specific methodologies. Asset Management provides investment advisory services to Company- sponsored mutual funds and asset management for institutional and individual clients. Private Client distributes a wide range of financial products through its branch distribution network, including equity and fixed income securities, proprietary and non-affiliated mutual funds and annuities. Net interest profit from customers' margin loan and credit account balances is included in this business segment. Capital Markets consists of the Company's equity and fixed income institutional sales and trading, syndicate, and corporate and public finance activities. Sales credits associated with underwritten offerings are reported in Private Client when sold through retail distribution channels and in Capital Markets when sold through institutional distribution channels. This business segment also includes realized and unrealized gains and losses on merchant banking and private equity activities and warrants acquired in connection with investment banking activities. 14 Other consists principally of the Company's real estate service business. Business segment financial results are as follows:
Three months ended Nine months ended December 31, December 31, 2001 2000 2001 2000 Net revenues: Asset Management........... $152,868 $113,042 $ 394,526 $ 330,783 Private Client............. 151,823 176,881 461,322 539,152 Capital Markets............ 62,512 50,454 176,489 127,722 Other...................... 7,563 8,708 23,819 24,462 $374,766 $349,085 $1,056,156 $1,022,119 Earnings before income tax provision: Asset Management........... $ 39,925 $ 34,220 $ 104,803 $ 98,966 Private Client............. 15,212 25,454 41,965 90,071 Capital Markets............ 11,300 9,162 29,638 9,855 Other...................... 567 915 919 2,626 $ 67,004 $ 69,751 $ 177,325 $ 201,518
The Company principally operates in the United States, United Kingdom and Canada. Results by geographic region are as follows:
Three months ended Nine months ended December, 31 December, 31 2001 2000 2001 2000 Net revenues: United States.............. $360,015 $331,923 $1,010,727 $ 973,972 United Kingdom............. 7,631 9,218 23,352 23,562 Canada..................... 7,120 7,944 22,077 24,585 $374,766 $349,085 $1,056,156 $1,022,119 Earnings before income tax provision: United States.............. $ 67,248 $ 67,759 $ 173,908 $ 199,842 United Kingdom............. (1,753) (1,716) (5,100) (8,312) Canada..................... 1,509 3,708 8,517 9,988 $ 67,004 $ 69,751 $ 177,325 $ 201,518
15 Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition Legg Mason, Inc. and its subsidiaries' (the "Company") profitability may vary significantly from period to period as a result of a variety of factors, including the volume of trading in securities, the volatility and general level of securities prices, and the demand for investment banking and mortgage banking services. Accordingly, sustained periods of unfavorable market conditions may adversely affect profitability. RESULTS OF OPERATIONS During the third fiscal quarter ended December 31, 2001, net revenues rose 7% to $374.8 million and net earnings and diluted earnings per share declined from the corresponding quarter to $41.1 million and $0.60, respectively. During the nine months ended December 31, 2001, net revenues rose 3% to $1.1 billion and net earnings and diluted earnings per share declined 10% to $106.8 million and $1.57, respectively, from the prior corresponding period. The decrease in net earnings in both the quarter and nine months was primarily the result of a significant decline in net interest profit, driven by lower average interest rates, lower margin account balances and higher acquisition-related debt costs, and lower retail securities transaction volume, offset in part by the addition of earnings of Private Capital Management ("PCM") and Royce & Associates ("Royce"). PCM, a high net worth investment manager, was acquired August 1, 2001 and Royce, which manages small-cap and micro-cap mutual funds, was acquired October 1, 2001. The results also include the effect of adopting Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets", which resulted in expense reductions of $1.9 million and $5.8 million and an increase of $0.02 and $0.07 in diluted earnings per share for the quarter and nine months, respectively. Quarter Ended December 31, 2001 Compared to Quarter Ended December 31, 2000 Revenues: In the quarter ended December 31, 2001, net revenues increased 7% to $374.8 million from $349.1 million in the prior year's quarter. Investment advisory and related fees: Investment advisory and related fees increased to $208.0 million, up 26% from the December 2000 quarter, substantially attributable to the addition of fees earned by PCM & Royce. Legg Mason subsidiaries served as investment advisors to individual and institutional accounts and mutual funds with an asset value of $170.1 billion, up 24% from $136.9 billion a year ago and up 8% from $157.4 billion at September 30, 2001. 15 Commissions: Commission revenues of $80.9 million decreased 13% from $92.7 million in the prior year's quarter, primarily as a result of a decrease in the volume of retail securities transactions, and sales of variable annuities and non-affiliated mutual funds, partially offset by a higher volume of institutional securities transactions. Additionally, the December 2001 quarter includes the addition of commission revenues of $2.1 million from PCM. Principal transactions: Revenues from principal transactions were $37.9 million, up 26% from $30.0 million in the prior year's quarter as a result of an increase in fixed income securities transaction volume, partially offset by a decrease in the volume of over-the-counter equity securities transactions. Investment banking: Investment banking revenues of $24.4 million were up 55% from $15.7 million in the corresponding prior year quarter, attributable to an increase in corporate banking activity, primarily selling concessions, and municipal banking fees. Other: Other revenues increased 18% to $19.1 million from $16.3 million in the prior year's quarter, primarily as a result of both net realized and unrealized gains on firm investments. Interest: Interest revenue decreased 54% to $33.5 million, from $73.3 million in the prior year's quarter, due to significantly lower average interest rates and lower client margin account balances, partially offset by an increase in average firm investment balances (predominantly funds segregated for regulatory purposes). Interest expense decreased 35% to $29.0 million from $44.6 million as a result of significantly lower average interest rates on client credit account balances, partially offset by increased interest on debt issued in connection with business acquisitions. Expenses: Compensation and benefits: Compensation and benefits increased 10% to $226.5 million from $206.0 million in the corresponding prior year quarter, primarily attributable 17 to the addition of expenses related to PCM and Royce and higher profitability-based incentives related to asset management activities. Communications and technology: Communications and technology expense declined 9% to $24.2 million from $26.6 million in the prior year's quarter as a result of decreased costs for quote and printing services. Occupancy: Occupancy was $15.2 million, up 18% from $12.9 million in the corresponding prior year quarter, primarily due to higher costs resulting from a new operations and technology center and prior year expansion at branch office locations, and the addition of expenses of acquired entities. Amortization of intangibles: Amortization of intangibles increased to $6.3 million from $2.9 million as a result of investment management contracts acquired in the PCM and Royce acquisitions, offset by the impact of adopting SFAS No. 142, as discussed previously. Other: Other expenses increased 15% to $35.6 million from $30.9 million in the corresponding prior year quarter, primarily as a result of an increase in the provision for litigation (see Note 7 of Notes to Consolidated Financial Statements) and the addition of costs from acquired entities, offset in part by a decline in promotional expenses. Additionally, the current quarter includes a $1.2 million charge related to acquired intangibles. Income tax provision: The income tax provision declined 9% to $25.9 million because of a decrease in pre-tax earnings. In addition, the effective income tax rate declined to 38.7% in the December 2001 quarter from 40.8% in the December 2000 quarter as a result of reduced state income taxes and the impact of adopting the provisions of SFAS No. 141 and SFAS No. 142, which eliminated amortization of goodwill and certain intangibles, which are non-deductible for tax purposes. Nine Months Ended December 31, 2001 Compared to Nine Months Ended December 31, 2000 Revenues: In the nine months ended December 31, 2001, net revenues increased 3% to $1.1 billion from $1.0 billion in the prior year period. 18 Investment advisory and related fees: Investment advisory and related fees increased 15% to $559.3 million from $487.7 million in the corresponding prior year period, principally as a result of fees earned by PCM and Royce, and growth in assets under management in fixed income investment advisory accounts. Commissions: Commission revenues of $243.6 million decreased 11% from $273.6 million in the corresponding prior year period, reflecting decreased volume of retail securities transactions and sales of non-affiliated mutual funds and variable annuities, partially offset by a higher volume of institutional securities transactions. Principal transactions: Revenues from principal transactions were $102.3 million, up 12% from $91.3 million in the corresponding prior year period as a result of increased volume of fixed income securities transactions, substantially offset by lower over-the-counter trading profits. Investment banking: Investment banking revenues increased 49% to $72.1 million from $48.2 million in the corresponding prior year period, attributable to an increase in corporate banking activity, primarily selling concessions, and municipal banking fees. Other: Other revenues increased 13% to $43.4 million from $38.4 million in the corresponding prior year period primarily as a result of both net realized and unrealized gains on firm investments and an increase in activity at the Company's mortgage banking subsidiary. Interest: Interest revenue decreased 37% to $137.1 million from $217.1 million in the comparative prior year period because of significantly lower average interest rates and lower client margin account balances, offset in part, by an increase in average firm investment balances (predominately funds segregated for regulatory purposes and temporarily-invested proceeds from debt issued for business acquisitions). Interest expense decreased 24% to $101.6 million from $134.1 million in the comparative prior year period as a result of significantly lower average interest rates on larger interest-bearing customer credit 19 balances. This decrease was partially offset by the impact of the addition of interest expense on debt related to business acquisitions. Expenses: Compensation and benefits: Compensation and benefits rose 7% to $642.7 million from $603.5 million, in the prior year's period, primarily attributable to higher profitability-based incentive expense, higher salaries and vesting of deferred compensation arrangements, partially offset by a decline in variable sales commissions. Communications and technology: Communications and technology expense declined 1% to $75.3 million from $75.9 million in the corresponding prior year period as a result of decreased costs for printing and quote services, offset in part by the addition of expenses of acquired entities. Occupancy: Occupancy increased 21% to $46.2 million from $38.3 million in the corresponding prior year period, as a result of prior year expansion, including new branch offices and a new operations and technology center, and the addition of expenses of acquired entities. Amortization of intangibles: Amortization of intangible assets increased 41% to $12.6 million from $9.0 million in the corresponding prior year period, primarily as a result of investment management contracts acquired in the PCM and Royce acquisitions, offset by a decrease resulting from the impact of adopting SFAS No. 142, as discussed previously. Other: Other expenses increased 9% to $102.0 million from $93.9 million in the prior year period, primarily as a result of an increase in the provision for litigation (see Note 7 of Notes to Consolidated Financial Statements), offset in part by declines in promotional expenses. Income tax provision: The income tax provision decreased 15% to $70.5 million because of a decrease in pre-tax earnings. The effective income tax rate decreased to 39.8% for the nine months ended December 31, 2001 from 41.0% for the comparable prior year period primarily as a result of reduced state income taxes and the impact of adopting the provisions of SFAS No. 141 and SFAS No. 142, which eliminated amortization of goodwill and certain intangibles, which are non-deductible for tax purposes. 20 Liquidity and Capital Resources Except for the issuance of long-term debt, the proceeds of which were used for business acquisitions described herein, there has been no material change in the Company's financial position since March 31, 2001. A substantial portion of the Company's assets is liquid, consisting mainly of cash and assets readily convertible into cash. These assets are financed principally by free credit balances, equity capital, long- term notes, bank lines of credit and other payables. During the nine months ended December 31, 2001, cash and cash equivalents increased $79.1 million. Investing activities used $807.8 million, principally resulting from payments for the acquisitions of PCM and Royce and a net increase in securities purchased under agreements to resell, partially offset by proceeds from sales and maturities of investment securities. Cash flows from financing activities provided $731.8 million, principally as a result of proceeds of $664.6 of long-term debt issued to fund the acquisitions of PCM and Royce. Cash flows from operating activities provided approximately $153.6 million, attributable to a net increase in customer payables and net earnings adjusted for depreciation and amortization, partially offset by higher levels of segregated cash and proprietary securities inventories. The Company may be required to make additional payments of up to approximately $800 million under business acquisition agreements (see Note 8 of Notes to Consolidated Financial Statements). In addition, at certain specified dates in the future, the first of which is June 6, 2003, or upon a change of control of the Company, the Company may be required to purchase the zero coupon convertible senior notes at the option of the holders at a price equal to the accreted value of the notes. For repurchase on the specified dates, the Company may elect to pay the purchase price in cash, shares of common stock, or any combination of cash and stock, while for repurchases upon change of control of the Company, the purchase price must be paid in cash. The maximum aggregate purchase price that the Company may be required to pay on June 6, 2003, is approximately $264 million. The Company expects to fund these commitments either through operations, available lines of credit or the capital markets. Forward-Looking Statements The Company has made in this report, and from time to time may otherwise make in its public filings, press releases and statements by Company management, "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 concerning the Company's operations, economic performance and financial condition. The words or phrases "can be", "expects", "may affect", "may depend", "believes", "estimate", "project" and similar words and phrases are intended to 21 identify such forward-looking statements. Such forward-looking statements are subject to various known and unknown risks and uncertainties and the Company cautions readers that any forward-looking information provided by or on behalf of the Company is not a guarantee of future performance. Actual results could differ materially from those anticipated in such forward-looking statements due to a number of factors, some of which are beyond the Company's control, in addition to those discussed elsewhere herein and in the Company's other public filings, press releases and statements by Company management, including (i) the volatile and competitive nature of the financial services business, (ii) changes in domestic and foreign economic and market conditions, (iii) the effect of federal, state and foreign regulation on the Company's business, (iv) market, credit and liquidity risks associated with the Company's investment management, underwriting, securities trading and market-making activities, (v) impairment of acquired intangible assets and goodwill, (vi) potential restrictions on the business of, and withdrawal of capital from, certain subsidiaries of the Company due to net capital requirements, (vii) potential liability under federal and state securities laws and (viii) the effect of acquisitions. Due to such risks, uncertainties and other factors, the Company cautions each person receiving such forward-looking information not to place undue reliance on such statements. All such forward-looking statements are current only as of the date on which such statements were made. The Company does not undertake any obligation to publicly update any forward-looking statement to reflect events or circumstances after the date on which any such statement is made or to reflect the occurrence of unanticipated events. Item 3. Quantitative and Qualitative Disclosures About Market Risk During the nine months ended December 31, 2001, the Company issued $425,000 principal amount of senior notes due July 2, 2008, which bear interest at 6.75% and $567,000 principal amount at maturity of zero- coupon convertible senior notes due June 6, 2031. Except for the debt issued during the period ended December 31, 2001, there were no material changes to the information contained in Part II, Item 7A of the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 2001. 22 Part II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K (a) Exhibits 3.1 Articles of Incorporation of the Company, as amended (incorporated by reference to Form 10-Q for the quarter ended September 30, 2000) 3.2 By-laws of the Company as amended and restated April 25, 1988 (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended March 31, 1988) 12. Computation of consolidated ratios of earnings to fixed charges (b) No reports on Form 8-K were filed during the quarter ended December 31, 2001. 23 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. LEGG MASON, INC. (Registrant) DATE:February 13,2002 /s/Timothy C. Scheve Timothy C. Scheve Senior Executive Vice President DATE:February 13,2002 /s/Charles J. Daley Jr. Charles J. Daley Jr. Senior Vice President and Treasurer 24 INDEX TO EXHIBITS 3.1 Articles of Incorporation of the Company, as amended (incorporated by reference to Form 10-Q for the quarter ended September 30, 2000) 3.2 By-laws of the Company as amended and restated April 25, 1988 (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended March 31, 1988) 12. Computation of consolidated ratios of earnings to fixed charges