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Legg Mason, Inc. (NYSE:LM)

F4Q10 Earnings Call

May 10, 2010 5:00 pm ET

Executives

Alan Magleby – Director of Investor Relations

Mark R. Fetting – Chairman of the Board, President & Chief Executive Officer

Charles J. Daley, Jr. – Chief Financial Officer, Senior Vice President & Treasurer

Analysts

Daniel Fannon – Jefferies & Co.

Michael Kim – Sandler O’Neil & Partners

Michael Carrier – Deutsche Bank Securities

William Katz – Citigroup

Jeffrey J. Hopson – Stifel Nicolaus & Company, Inc.

Analyst for Roger Freeman – Barclays Capital

Glenn Schorr – UBS

Douglas Sipkin – Ticonderoga Securities

Cynthia Mayer – Bank of America Merrill Lynch

[Matt Spikes – Capelli & Company]

Roger Smith – Macquarie Research Equities

Marc Irizarry – Goldman Sachs

Operator

Welcome to the Legg Mason quarterly conference call. At this time all participants are in a listen only mode. After the speakers’ remarks we will conduct a question and answer session and instructions will follow at that time. (Operator Instructions) As a reminder, this conference call is being recorded. I would now like to turn the call over to your host Alan Magleby, Director of Investor Relations.

Alan Magleby

On behalf of Legg Mason, I would like to welcome you to our conference call to discuss operating results for the fiscal 2010 fourth quarter and fiscal year ended March 31, 2010. This presentation may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not statements of facts or guarantees of future performance and are subject to risks, uncertainties and other factors that may cause actual results to differ materially from those discussed in the statements.

For a discussion of these risks and uncertainties, please see risk factors and managements’ discussion and analysis of financial conditions and results of operations in the company’s annual report on Form 10K for the fiscal year ended March 31, 2009 and on the company’s quarterly results on Form 10Q. This afternoon’s call will include remarks from the following speakers, Mr. Mark Fetting, Chairman and CEO and Mr. CJ Daley who will discuss Legg Mason’s financial results.

In addition, the following review of the company’s quarter and fiscal year and other matters we will then open the call to Q&A. Now, I would like to turn this call over to Mr. Mark Fetting.

Mark R. Fetting

Today we walk you through our results and our plans for the future. We restored strength to our balance sheet, delivered strong investment performance, solid cash earnings, increased our dividend by over 30% and announced a stock buyback of up to $1 billion and as you saw in our earnings release, we are announcing a streamlining of our model to meet the realities of our business head on and to affectively serve our clients.

Following strong performance in fiscal year 2010, our affiliates businesses have stabilized and many are growing or are poised for growth in the coming quarters. We are now setting our focus on two critical areas: growth through serving our clients; and operating margin. We looked at every aspect of our business, had extensive discussions with our affiliate leaders and other key constituents to determine how best to organize our business for the future as a firm of specialized investment managers.

We will walk you through the changes to our business model at a high level today which involves focusing Legg Mason’s resources on where we can add strategic value while transitioning certain functions to affiliates. We will go in to more details on that as well as our growth opportunities at our investor day which is scheduled for Thursday, May 13th. Last week volatility returned to the market which I believe underscores the benefit of active management versus the sometime perils of passive programs and complex trading protocols.

Let’s turn to the investor deck and page two. I am pleased to report our best quarter in two years. We’ve now reported four straight quarters of profitability. This quarter, Legg Mason reported net income of $64 million, cash income as adjusted for the fourth quarter of $111 million and EBITDA as adjusted with $157 million. We’ve taken steps to restore strength to our balance sheet after weathering the credit crises in 2008. We have lowered our debt to total capital ratio to 20% and CJ will provide more detail during his part of the presentation.

We continue to focus on cost and generating cash. In fact, as you’ve also seen from today’s release the board has authorized $1 billion share repurchase program so we will take some of our excess cash and return it to shareholders. Over the past year we have more actively engaged with our affiliates. We believe we have come out of that process with a strong plan to grow our franchises. Our commitment to the multi manager model and to investment excellence remains adamant.

Move to page three, let’s look at our year in progress. We’ve been hard at work through our distribution organizations to improve sales, stronger investment performance across many of our key managers has helped. This year we brought improvement to both domestic and international distribution channels and we believe we are poised to continue that progress with continued strong investment performance in to fiscal 2011.

I am particularly pleased that American Distribution had positive flows in the fourth quarter which is the first time they have had positive net flows in nearly three years. In international distribution we’ve had five consecutive quarters of inflows and closed the year with significant net inflows compared to net outflows in fiscal ’09. Finally, we continue to look at expanding our capabilities. We have worked with and added investment, credit and risk management professionals at Western and Brandywine. We recently did a bolt on acquisition of Wyper Asset Management with Royce which we think is a great addition. We are looking at other transactions around strategic needs with an eye on culture and appropriate economics.

On page four, we show graphically our streamlined business model. We have simplified the graph to make clear that Legg Mason is about two basic components, world class investment affiliates and a corporate center of strategic services to assist those managers in serving clients better and in allocating capital for future growth and shareholder value. First and foremost is our affiliates, we remain committed to the multi manager model with our affiliates delivering customized investment solutions and eliminating some redundancies between corporate and the affiliates.

Corporate will retain activities where we can have significant strategic impact. This means that we will focus on capital allocation, distribution and investment in our franchises whether that is new investment talent or seating new products to fuel growth. With a strong balance sheet, we are well positioned to do that. The distribution effort we have built has compelling value and we expect to build on our momentum, particularly as performance comes back.

The investments we have made in the Americas and international retail distribution are paying off through sales growth and we believe the infrastructure is capital of supporting substantially increased volumes. It will be an important component of growth for us. None of this streamlining will impact investment areas. We believe that delivering client value will drive shareholder value.

Page five speaks to the high level impact of the streamlined model announced today. We are transitioning certain shared services to affiliates which we think will better position them to deliver the specialized solutions that their clients demand. Both we and the investment affiliates believe that they can execute these functions in a more cost efficient manner as they have a number of options to manage these services and can scale them to their needs either in house or by outsourcing to a scale service provider.

Currently, several of our affiliates already handle the day-to-day operations of their business. Other affiliates handle some of these services to varying degrees and we will transition remaining shared services to them over time, over a period of 12 to 18 months. We will balance getting this process completed expeditiously while ensuring we get the transition right for our clients and our affiliates.

In total, we expect that these initiatives will significantly reduce our cost structure and drive material margin improvement. We expect that we can achieve $130 to $150 million in cost benefit over a 12 to 18 month period and a six to eight point improvement in margin. And, we see multiple opportunities to drive shareholder value going forward. This includes top line growth from two sources affiliates marketing directly to institutional clients augmented by Legg Mason’s strong retail distribution globally. And, the board as approved an accretive share repurchase program, a compelling capital use given our growth prospects versus our current valuation.

On Slide Six, we talk about performance. As you can see, performance remains solid. Across all time periods we are much improved from the year ago market lows. Page seven acknowledges the awards that we have been granted over the past year across the world and in numerous categories. We believe this validates decisions we made during the market turmoil to allow our investment managers autonomy. While all evaluated their investment processes in the wake of performance issues any changes were done in the context of an investment philosophy that has always worked for them and their clients over the long term.

On page eight, let’s look at our total long term net flow story. As you can see, outflows moderated again this quarter down 63% since last quarter. When compared against fiscal ’09, net outflows for the year decreased over 40%. Equity outflows continued to moderate further this quarter to about $2 billion. Fixed income outflows continue to be choppy but are much improved at $8 billion from the December quarter outflows of $24. We previously discussed yearend seasonality relative to last quarter’s outflows and the numbers have born that out. Liquidity outflows were approximately a billion as compared with much higher outflows of 5% for the month and 9% for the quarter on an organic basis.

Slide nine shows our assets under management. We are at $685 billion, up 8% over the prior year with 25% in equity, 53% in fixed income and 22% in liquidity. Slide 10 speaks to our AUM by affiliate in order of their contribution to earnings. I am pleased to report that substantial year-over-year improvement from our investment managers virtually across the board. Our businesses are stabilizing and our affiliates are either growing again or poised to do so in the coming quarters.

Let’s start with Western; as you saw earlier out flows moderated this quarter and they are seeing positive trends in many aspects of their business. New accounts from existing clients were nearly 71% higher this quarter over last while net outflows from lost accounts dropped by approximately 60% over the same time period. Western continues to win business in local currency products outside the US and in customized portfolios. As strong performance increasingly rolls in to longer term numbers, we believe that they will be attractively positioned particularly in the second half of the year.

Next is Permal; sales in the quarter were strong with accelerated investor interest in March with growth in flows of over $1 billion. Investor interest came from all regions and included a healthy mix of high net worth and institutions. Their institutional business, a relatively new segment for Permal is becoming a more significant part of our asset mix. They’ve seen particular interest in fixed income and global macro products and funds have continued to be added to new and existing distributor platforms. They have also expanded their separately managed account platform, a format that gives them additional flexibility to deliver solutions to clients and that now accounts for approximately 25% of their assets under management.

ClearBridge; ClearBridge is making steady progress in expanding in to new channels with several mandates this quarter. While overall flows from the mandates were modest this quarter, their products are being added to model portfolio programs which should bring additional flows in the future. These are the kind of mandates we want to win going forward.

Next is Royce; they saw net flows of about $1 billion for the quarter, the bulk of which went in to several of their flagship funds with the rest across a number of strategies and, as I mentioned earlier they’ve added George Wyper and his team to the group which gives them additional capabilities in the institutional space.

Brandywine’s assets reflect about $200 million in positive flows for the quarter as well as market appreciation. Global fixed income performance has rebounded after a tough 2008. All of their global fixed income composites are outperforming benchmarks over all time periods. Our partnership with Brandywine in the America’s channel continues to have strong momentum with over $500 million won across two clients for the large cap value product.

Legg Mason Capital Management continues to see positive flows in their offshore funds and are seeing increased sales in the US funds. They received an allocation of over $200 million from one institutional client last quarter and their institutional pipeline is starting to build this quarter with the win from a sovereign client and they were added to a model at a coveted distribution intermediary.

Batterymarch; the markets have begun rewarding fundamentals which is good for Batterymarch. Strong recent performance in their global emerging market product resulted in both client in flows for the quarter and new interest. Legg Mason Japan and Batterymarch launched a new fund that saw good initial interest during the quarter and has continued to experience net positive flows through April. Finally, our assets under management from international clients is now at 35%.

If you take a look at America’s distribution, this is the first full year of results since we restructured the organization last year. We are pleased with the progress we have made in overall flows and expansion of our channels in to new national broker/dealer and independent advisory relationships. We had the first net positive flow quarter for the division since the first quarter of ’07 and fiscal year-to-date flows have improved by 78%.

Underlying the numbers on the graph, growth sales tended higher while redemption rates have generally been improving since December of ’08. Over the past year we have raised over $700 million in closed end funds. Not only does it make us one of the fundraising leaders last year but it also raises our profiles in new distribution channels. As just one example, we have significantly expanded the business we do across our product base with Bank of America Merrill as a result of our relationships with them in the close end fund area. So some great cross verticalization.

If we look at international, we continue to see improving trends in the international distribution area. This was our fifth straight quarter of positive flows. Assets grew to $40 billion over the past year, up 25% from the March ’09 quarter. We continue to see the strongest flows from the regions where we’ve had the longest presence led by Japan, then Europe and our Americas offshore product. Flows here were led by Western, than Royce and Permal.

Now, I will turn it over to CJ for a walk through our financial results.

Charles J. Daley, Jr.

We finished the fiscal year with a strong fourth quarter of earnings, margin expansion and cash income as adjusted. Our balance sheet is also strong with approximately $1 billion of excess cash and significantly reduced levels of debt from a year ago. Investment performance which typically leads to improved client flow activity is also very encouraging as we saw significantly improved year-over-year performance across our managers.

With that summary, let’s begin with our full year fiscal results which are on Slide 13 and 14 of the investor deck. For the full year, cash income as adjusted was $381 million compared to a cash loss of $1.2 billion in the prior year. GAAP earnings were $204 million or $1.32 per share compared to a net loss of $2.0 billion in fiscal 2009. The prior fiscal year included after tax charges for money fund support of $1.4 billion and intangible impairments of $863 million. Total operating revenues for the fiscal year were $2.6 billion, down from $3.4 billion as a result of average AUM declines of 17% during the year.

Our fourth quarter results are on Slide 15 and 16. This quarter’s net income was $64 million or $0.39 per diluted share, our best quarterly results in the past two years. Operating revenues were $671 million and were down 3% largely due to lower average AUM, fewer days in the quarter, higher fee waivers in liquidity products and as expected lower performance fees. However, our effective advisory fee, despite the increase in fee waivers increased a basis point this quarter to 33 as a result of the impact of increasing equity assets as a percentage of total assets under management. As you know, we earn higher fees on equity assets we manage.

We generated $25 million in performance fees this quarter and that’s only slightly lower than the prior quarter which was our calendar yearend quarter. Our results were also better than the range I previously provided on last quarter’s earning call of $10 to $20 million thanks to continued strong investment performance at Permal, Western and this quarter at Brandywine. The expectation for our performance fees remains in the range previously given but should come in at the high end of that range or slightly better as shown this quarter assuming investment performance continues to be strong.

Operating expenses were lower as last quarter’s results included $28 million in real estate losses. This quarter includes A typical items resulting in a net charge of $4.2 million or approximately $0.02 per diluted share representing the net effect of an investor settlement and a sublease recovery. Almost all of the remaining vacant space we have left has now been sublet. All of this translated in to cash income as adjusted of $111 million or $0.69 per diluted share.

Diluted earnings per share on a GAAP basis was $0.39 per share, 39% higher than December’s quarterly earnings of $0.28 per share and represents our fourth consecutive quarter of profitability. Our compensation and benefits ratio improved to 51%, significantly better than the range we have achieved over the past several quarters. Several factors contributed to this lower ratio including a lower revenue sharing compensation on lower revenues which also led to a reduction in bonus accruals as well as a revenue sharing impact of the investor settlement in mentioned previously.

Our usual detailed operating expense and compensation slides are provided in the appendix of this deck. Operating margin as adjusted is trended on Slide 17, almost 23.2% this quarter up from 17.9% last quarter. We have continued to improve margins from our low point in the March ’09 quarter but as Mark noted we continue to lag peers on this measure and the actions announced today aim to reduce that disparity for the next 18 months.

On Slide 18 is our condensed consolidated balance sheet. A strategic priority in fiscal 2010 was to strengthen our balance sheet and specifically the fundamentals around the leverage we incurred in the prior year. So after layering on $2.9 billion of debt to resolve the SIV issues, we focused on delivering in fiscal 2010 and during this fiscal year we were able to reduce our debt significant as we repaid $550 million of our term loan and revolving credit facility and we accelerated conversion of $1 billion of our equity units to equity two years in advance.

As a result of these actions, our debt to capital ratio now stands at 20%, down from 39% and on Slide 19 you can see the improvement in our debt covenant ratios which calculated on a trailing 12 month period reached their trough in the December quarter.

Moving on to Slide 20, within the context of vastly improved balance sheet, improved earnings and strong cash flow generation, we are now in a position to turn our attention to utilizing capital to drive greater shareholder value. We have built up substantial excess capital with strong free cash flow generation so we believe it is appropriate now to begin to deploy our excess capital in ways to drive greater value.

As a result, the board today authorized the company to repurchase up to $1 billion of common stock. We intend to execute the repurchase plan with an initial purchase of up to $300 million by the end of September and then repurchase quarterly in the open market utilizing a portion of our cash flow each quarter. Our execution plans will be monitored and revised as needed based on market conditions and may be accelerated or scaled back based on actual cash flows and capital needs.

We believe that execution strategy captures the value opportunity inherent in our current stock price by making an initial accelerated purchase followed by systematic and disciplined purchases thereafter balances our philosophy to be prudent in our capital management approach yet capture immediate shareholder value.

Finally, I want to comment on the financial impact of the streamlining of our business model. As Mark mentioned, the plan to transition selected shared services to our affiliates reflects our belief in the attractiveness of the multi manager model while recognizing that modifications to the way that we execute that model can drive greater value to the Legg Mason shareholder. Specifically, transitioning certain shared services to our affiliates allows the affiliates to drive more value for the client in a more nimble and efficient structure.

For our corporate center, transitioning the services to the affiliates plus the revenue that our domestic distribution capabilities will earn on organic AUM growth will allows us to reduce costs by $130 to $150 million annually and eliminate all but distribution and pure parent company costs at the corporate level.

The transition of these services will occur over a 12 to 18 month period and we expect that you will begin to see the full impact of the savings beginning in quarter four of fiscal 2010. In the interim, the savings will be offset by the incurrence of transition and restructuring costs of approximately $190 to $210 million as we retain the resources required over this period to transition these services. Our expectation is the current impact on our pro forma basis fully implemented will be approximately six to eight percentage points improvement in our operating margin before income taxes.

With that, I will turn it back to Mark who has some closing comments before we open it up for Q and A.

Mark R. Fetting

Before we open it up to questions I’m going to close with some key points. Today, we announced our best quarter in two years and a plan to streamline our business model to serve our clients and our investors as a firm of specialized investment managers. Our investment managers are gaining momentum on strong investment results. We are transitioning shared services where it makes sense.

We will invest in leveraging our retail distribution in the Americas and internationally to add to the growth equation in a meaningful away. Furthermore, our capital and strong cash generation gives us significant flexibility to continue to invest in and with our affiliates. In total, we expect to significantly reduce the cost structure and drive material margin improvement. We expect to deliver $130 to $150 million in cost benefits over a 12 to 18 month period of time and six to eight points in margin improvement.

We believe our prospects for shareholder value are so attractive against current valuation that we are repurchasing our own shares. Finally, we look at our future, we are focused on growth through serving our clients, strategic capital allocation going forward and CJ and I look forward to opening it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Daniel Fannon – Jefferies & Co.

Daniel Fannon – Jefferies & Co.

On the new initiatives or the expense reduction programs, is this going to be shared across all the affiliates? I just want to make sure also that the Legg Mason corporate will still handle the majority of the retail distribution here or is all kind of distribution now the way you do it currently going to be pushed back to the affiliates?

Mark R. Fetting

We’ve been working as we said much more closely with the affiliates throughout the two years plus that I’ve served as CEO and most recently on this plan. What this plan is about is streamlining the shared services but on the distribution in the retail and what we call quasi retail businesses we would continue to provide that on a centralized basis in the America’s and international and leverage the affiliates in that way but they would continue to market directly to the institutions as they have always done.

Daniel Fannon – Jefferies & Co.

As you said I think in your presentation that not all affiliates use these services or have historically so I assume this is more Western or some of the larger affiliates that are going to have some changes to their model?

Charles J. Daley, Jr.

Well, I think what we’ve tried to make clear is that we’ve done this with the affiliates. Some of the affiliates do most of their shared services and they’re really not impacted. I would say Western would be a good example of that. On the other hand, others have used this for a portion of what they do. The decision here was as you look structurally, what could we do at corporate. It was not really adding value in spite of the good work our folks were doing there as opposed to enabling the affiliate to take it on closer to the client and do it in a more effective and efficient way. We are working with the affiliates to transition this over a 12 to 18 month period of time so that they are as confident that we are that we can do this in a seamless way for clients.

Daniel Fannon – Jefferies & Co.

Then with the billion dollar buyback as you kind of think about that deployment of capital, are you still looking at potential bolt on or lift out acquisitions to complement your current business mix?

Mark R. Fetting

Yes, and I think that was important to kind of give everybody and update. We worked with several of our affiliates Western and Brandywine in particular who have been able to add some key hires and our support affiliated those additions. I would call those kind of almost lift out like situations and then with Royce we actually worked with a bolt on relative to Wyper Asset Management. We see that continuing as kind of near term opportunities.

Operator

Your next question comes from Michael Kim – Sandler O’Neil & Partners.

Michael Kim – Sandler O’Neil & Partners

First maybe just to follow up on the streamlining, are there going to be any changes to the revenue sharing agreements with the affiliates and have all of the affiliates signed off at this point? Then finally, was there any sort of push back on their end as it relates to internalizing some of the costs?

Charles J. Daley, Jr.

Well, I think as I said on the last call the last quarter, we felt like we made a lot of progress in terms of adjusting things through the crisis period but then when you look structurally we were still lacking from a margin standpoint and it had to be kind of with the overlap between affiliate and corporate activities. The affiliates accept and support what we’re doing. In some cases they are taking on some additional activities and some additional charges but we’re working in that transition and I think what has really jelled is a commitment to kind of be able to do this in such a way that we’re investing strategically going forward where it makes sense. Corporate resources going forward are going to work with the affiliates whether it be growing their businesses, adding capability, seeding products and we’re able to kind of basically take these savings and have that generate added capital for deployment going forward.

Operator

Your next question comes from Michael Carrier – Deutsche Bank Securities.

Michael Carrier – Deutsche Bank Securities

Just one more question on the new initiatives, it looks like when you get the full run rate in to place it will be calendar year 2012 so obviously a lot can happen between now and then. So, I’m just trying to figure out when you look at that $130 to $150 million in cost saves and then particular on the margin upside the six to eight percentage points two questions would be what are you baking in on the revenue side in terms of upside from some of the revenue sharing agreements on the American Distribution side? Then also, if we get in to a more difficult market environment, should we still expect those costs savings or obviously it just depends on the environment?

Mark R. Fetting

Well CJ can run you through just some high level of the kind of assumptions behind it. The bottom line is that most of this is around some cost reductions that we’re doing going in to the transitions and some pick up of services that is based on advanced work that we’ve done we’re highly confident that can be done candidly less expensively at the affiliate level than we were incurring at the corporate level and yet actually has better kind of customization. So the stress testing that we’ve done around market scenarios give us comfort that we can achieve that on a good range, a fulsome range. CJ do you want to hit any more specifics?

Charles J. Daley, Jr.

I mean what we tried to do here is not project what our revenues and profits are going to be over the next three years but sort of give you the fully implemented pro forma impact on today’s numbers so you shouldn’t read in to any growth rates or anything like that to achieve this. This is actions that we think we can take today although they’re going to take 12 to 18 months so the impact could be more or less depending on where our revenues are three years from now.

Michael Carrier – Deutsche Bank Securities

Then can you just give a little bit more detail just in terms of what the corporate will be doing and then what the affiliates will be doing just in terms of the breakdown of the services because it makes sense, meaning in terms of affiliates sharing some of the services but I’m just trying to understand what each of the entities will and won’t be doing going forward?

Mark R. Fetting

That’s a great question and if you just go to page four on our streamline model, you may recall we actually had three boxes before we got to the shareholder value, we’re now down to two. That should be very clear that we’re coming out of this streamlined and simplified, that there are two component pieces to value for clients and shareholders that Legg Mason. First and foremost are the affiliates and we say they’re investing, the affiliates have always operated independently relative to their investment process, their investment teams, etc. and that continues. There is no impact by the streamlining on that piece.

They’ve also always dealt directly with their institutional clients business, that continues. They will pick up some of the investment operations under the hood of this that we’ve done for some of the affiliates. The larger affiliates have already been doing this for themselves in many cases. On the strategic services at corporate we have the principal activity of retail distribution and that’s in the retail and quasi retail, largely the mutual fund and retailed managed account businesses that we do globally that they will continue to rely on us and we’ll work even more closely with them on making sure we’re getting good value, we’re delivering good value, etc.

Then, we’ll continue to provide I think critical corporate functions of capital allocation in terms of investing affiliates, adding affiliates, etc. and just ongoing business development. If you think about it in a different way, the headcount reduction that we’re announcing is all on the corporate side so if we have about 3,600 employees today almost 2,000 of which are at the affiliates and we have about 1,600 on the corporate, the 1,600 in corporate is going to go down by 350, the affiliates may pick up some but really not nearly as much as that 350 because some of them are already doing it and the others are probably going to do it with their existing teams and in some cases outsourcing.

Operator

Your next question comes from William Katz – Citigroup.

William Katz – Citigroup

I just wanted to sort of follow up on the expense side again. In some of the prior conference calls you mentioned that you had sort of washed out your expenses pretty strongly already and I’m sort of wondering what services in particular are getting pushed down? You keep talking in very generic terms but can you talk specifically about which affiliates are being affected? Then, from the other side of the equation, what’s the economic enticement for the affiliate to absorb these costs?

Mark R. Fetting

The area that’s most populated on this is the operations and technology and those are largely investment operation functions on kind of technology operations and then project management around the application of those operations. Much of it is tied more to the equity affiliates that are fixed income side or to that extent the alternative side. Relative to the incentive of taking on these costs was really a mutual discussion around together I saw and we see the need to really improve our margin on behalf of the shareholders which ultimately benefits the affiliates in terms of our ability to support and be able to grow the businesses.

Relative to other alternatives that we considered, this was the one that really we came together on. So I think straight talk, it’s not something that all of them would have desired relative to the kind of historic pattern of providing services at no charge but that status quo just wasn’t going to continue on a go forward basis and I think all accepted and supported that.

Operator

Your next question comes from Jeffrey J. Hopson – Stifel Nicolaus & Company, Inc.

Jeffrey J. Hopson – Stifel Nicolaus & Company, Inc.

Just to hit this maybe one more time, so economically to them with revenue sharing adjustments could they be potentially earning less at the affiliate level? Then in terms of timing of savings, I’ve heard and maybe I’m hearing this wrong is it back end loaded or will there be a gradual affect going forward? So in the very near term is there going to be any net savings I guess?

Mark R. Fetting

Let me take the first one and then CJ will hit the timing piece and maybe I should be more clear relative to a couple of other questions that have come up. There have been no changes to the revenue sharing for those that are on revenue sharing. This is something that accumulated incrementally and we’ve resolved incrementally if you will. We are providing a bridge with the affiliates that is part of that 12 to 18 month transition and restructuring charge to enable them to transition successfully.

It won’t impact the investment areas and the affiliates together and you will all hear more directly at the investor day where we’re talking together confirmation that we all believe this is the right plan going forward. CJ why don’t you hit the timing piece.

Charles J. Daley, Jr.

You can think of this process in sort of two phases, one there’s the elimination of services and then there’s the transition costs that are required to be incurred which is basically retaining individuals to transfer those costs. So you will not begin to see savings until those transitions have occurred and because you’ll have costs, transition costs that will be offsetting those. What we’ll attempt to do is try to as best we can break out those transition costs in our P&L and make it clear so that you can track our progress as we go forward. But, the short answer to your question is you’ll begin to see those savings in a material way in the later end of fiscal ’12.

Mark R. Fetting

And, I think as we said earlier and we also ought to punctuate, that $130 to $150 is based on base case kind of market conditions. If there’s a severe setback that will be a challenge, but we don’t anticipate it. If there’s a severe upside, it can happen sooner. So we’re kind of working on those normalized conditions and a good chunk of that does have the benefit of some explicit cost saves we’re doing going in and some advanced discussions we’ve had with certain affiliates around how quickly they can move.

Operator

Your next question comes from Analyst for Roger Freeman – Barclays Capital.

Analyst for Roger Freeman – Barclays Capital

I just want to think about the M&A outlook and how both those strategic initiatives maybe changed the type of discussion you’re having in terms of adding small bolt on acquisitions or any additional type of affiliate acquisitions?

Mark R. Fetting

That’s a very good question. The attraction we have to what we always target as best in class managers is first and foremost a commitment for them to continue investing as they have and kind of largely on an autonomous basis around the investing discipline. The next piece that they’re attracted to is our distribution. That’s where we can help them more often or not, they want to kind of maintain a more investment oriented culture and composition of professionals and enable us to kind of leverage off our preexisting retail and distribution capabilities both in the US and globally.

Then finally is this kind of strategic piece which is the deployment of capital where we can help add some next generation teams and opportunities, etc. I don’t think, it may be implied in your question that taking this step of streamlining makes us any less attractive as a partner going forward and if anything, I think sharpens our ability to add value in those areas.

Analyst for Roger Freeman – Barclays Capital

Then just to kind of switch gears I was wondering about the flow picture, particularly as I look at the money market business, any kind of update you can give us as we’re about half way through the June quarter?

Mark R. Fetting

Well the money market business, I will on behalf of the industry make clear that we as a reasonably good size player with about $150 billion under management and liquidity feel very strongly that maintaining a stable NAV is a core principle to our product that our clients invest in and the issuers rely on and so we would hope that that prevails and we think that prevails. On the kind of quarter that is underway, as everybody knows I assume on the call this is 3/31 so it’s our fiscal year end so we’re doing this about a week or so later than normal to kind of wrap up the annual cycle.

We’re going to stick to the discipline, we will announce I guess April AUM at the investor day which is consistent but directionally I think we thus far are pleased to see continued momentum around improvement in the fixed income and equity side generally and then the liquidity side is moving. We’ve been somewhat counter the industry and you can get some visibility of that on your own so I think it wouldn’t surprise me to see some outflows there.

Operator

Your next question comes from Glenn Schorr – UBS.

Glenn Schorr – UBS

The first question on institutional performance, I saw the slides on six and 24 on the retail side, did I miss something or can you comment on trends on the institutional side?

Mark R. Fetting

That’s good clarification Glenn because most of the performance data is off the retail indices. The institutional is quite similar directionally in the sense that we I think manager by manager continue to deliver strong performance recovery. Western, throughout virtually all of their strategies have done extremely well, capital management opportunity, trust, value and special that both Bill Miller and Sam Peters lead have done extremely well. Permal has continued to deliver consistently strong performance and their institutional piece is becoming more a part of their story so those are some highlights. I’d be happy to follow up on anything specific.

Glenn Schorr – UBS

Than lastly, just curious on the buyback parameters you had mentioned potentially accelerated up front and then some more as a percentage of cash flow as you go forward. What valuation parameters, if any, do you put around what’s an attractive valuation versus not? I realize that you feel margins are suppressed right now so you might do some more up front.

Charles J. Daley, Jr.

We really haven’t committed to anything beyond the initial $300. We’re going to take a look at a number of factors around valuation, cash flow, cash needs so we’ll take all of those into consideration after we complete the initial purchase of $300 over the next several weeks or so. But, you wouldn’t expect to see anything beyond that until after we complete that which will probably take 45 to 75 days through open market purchases after we execute the initial accelerated contract.

Mark R. Fetting

I would just add a little bit on that in terms of if you step back, we would certainly collectively on behalf of our managers see the glass as more half full than half empty relative to market opportunities and fundamental improvements irrespective of the kind of trading issues I alluded to earlier in the call. With that, we would hope to continue to outperform, enhance the opportunity for our assets to grow and revenues to grow. We than have the opportunity on a more streamlined basis to deliver more to the bottom line and if we do that we think we will deliver a basis for fundamentally stronger valuation of the company against where it is now. So long as those parameters continue, the board thinks it is a good use of capital on a prudent basis to take advantage of that.

Operator

Your next question comes from Douglas Sipkin – Ticonderoga Securities.

Douglas Sipkin – Ticonderoga Securities

Just a question on Permal, obviously strong performance you’re seeing that in the performance fees and I think you guys mentioned the stronger growth sales. I’m just trying to get a sense of when you guys expect sort of net flows to turn positive. I see the assets are down about $500 million sequentially, is that just a function of runoff of funds of funds which went through a traumatic period or is there something else going on there?

Mark R. Fetting

That’s actually a very perceptive question because the fact is, and I should kind of hit a little harder, they have been hard at work from a product design standpoint to kind of clean out some business that they felt through the cycle of the crisis was lesser in quality, that’s largely behind them. So on a go forward basis you’ll see more directly there is an uptick in the sales levels and a significant reduction in the redemption levels and I think we’ve referenced that March was a strong month for them, early indicators is April continues that way so we are quite enthused at what is a more diversified business with both institutional and kind of traditional high net worth clients.

Also, from a product standpoint this ability, and they are one of the few leaders in the market that can do this to kind of bolster their product with this separate account relationship with an underlying hedge manager as opposed to just a co-mingled which gives them more currency and clout in the marketplace in attracting new clients.

Operator

Your next question comes from Cynthia Mayer – Bank of America Merrill Lynch.

Cynthia Mayer – Bank of America Merrill Lynch

Maybe just to clarify, when you say operations and technology are you talking about like shareholder servicing and accounting?

Mark R. Fetting

Yes. Most of this work Cynthia is being done to support their investment operations so what we’re not talking about when we mention that is the fund accounting capability we have in New York. We’re going to continue in all the areas to look where we can be more efficient but when we talk about the shared services, we’re really talking about the areas supporting the investment operations which is largely done out or red run facility in Maryland.

Cynthia Mayer – Bank of America Merrill Lynch

On the 6% to 8% margin improvement, this sort of implies a onetime step up but not necessarily a change in your model whereby you have more operating leverage than before, am I interpreting that right?

Mark R. Fetting

I think that’s a good point. On a go forward basis, as we reduce the corporate expense, it gives us a more kind of measured ability and on the upside that will come from assets and in those affiliate areas that aren’t on a revenue share.

Operator

Your next question comes from [Matt Spikes – Capelli & Company].

[Matt Spikes – Capelli & Company]

Just one quick question and then one follow up. Do you expect any impacts to redemptions, the flow of redemptions based on the transitioning, the streamlining?

Mark R. Fetting

Not at all, this is more behind the scenes so this doesn’t involve our teams in Stanford where our sales desk is, etc. that are really more on the distribution side. So, I think they have been very effective at reducing redemptions. Then, this doesn’t impact on the affiliate side, their client service operations, it’s really behind the scenes operation technology services.

[Matt Spikes – Capelli & Company]

On the industry M&A just thinking, are you seeing any evidence that people are more motivated by doing deals maybe in the second half based on the thought that taxes will be impacting them in the future? Do you expect maybe more motivated sellers and maybe a pickup in M&A?

Mark R. Fetting

There’s definitely some evidence of that particularly on firms that are specialist principle owned. How that translates kind of in to completed deals remains to be seen but I would concur that there’s some of that going on.

Operator

Your next question comes from Roger Smith – Macquarie Research Equities.

Roger Smith – Macquarie Research Equities

I just have a couple of maybe little clarifications. On the settlement reserve was that really from a line item perspective a $6 million benefit on the comp line?

Charles J. Daley, Jr.

That’s approximately the right number, that’s correct.

Roger Smith – Macquarie Research Equities

Then can you just give me an idea what that investor settlement is all about?

Charles J. Daley, Jr.

Well, as we said operating expenses this quarter were up. It was driven by an affiliate investor settlement. The pre-tax amount of about $12.5 million after a revenue sharing adjustment and related to a unique situation with a non-US investor and product it was created seven years ago and liquidated last year.

Roger Smith – Macquarie Research Equities

Then on the real estate charges that were taken in the past, it looks like we got an $8.5 million benefit this quarter from those. Is there potential for additional benefits going forward or should we think that’s all taken care of?

Charles J. Daley, Jr.

You should think that’s all taken care of. We still have a small amount of space in New York that we have not sublet yet but it’s not much at this point and so almost all of our space has now been sublet.

Operator

I’d like to turn the call over to Alan Magleby.

Mark R. Fetting

I’d like to wrap up and thank everybody. This is a quarter where we had three key themes. One, is continued progress and turnaround in terms of results to our clients and financial results to our shareholders. Two, is the balance sheet has become strong enough that our board has authorized us to take advantage of what we see as real value at current valuations in terms of a buyback. Third, more broadly than just streamlining is I think a recognition that we seen an opportunity to simplify and streamline the dynamic between our affiliates who are the starting engine of the business and our corporate team who should provide strategic services in such a way that we continue to deliver strong performance in what we expect and hope to be a stronger investor environment for shareholders going forward than the decade of the past and an opportunity to take those investment results and translate them in to real value for our shareholders. We look forward to continuing to keep you posted on our progress and thank you for your interest in Legg Mason.

Operator

Ladies and gentlemen thank you for your participation in today’s conference. This concludes the conference and you may now disconnect.

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Source: Legg Mason, Inc. F4Q10 (Quarter End 03/31/10) Earnings Call Transcript

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