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Legg Mason, Inc. (NYSE:LM)

F1Q11 (Qtr End 06/30/10) Earnings Call

July 26, 2010 5:00 pm ET

Executives

Alan Magleby – Director, IR and Communications

Mark Fetting – Chairman and CEO

Terrence Murphy – Interim CFO

Joe Sullivan – Senior EVP and Chief Administrative Officer

Analysts

Bill Katz – Citigroup

Dan Fannon – Jefferies & Company

Jeff Hopson – Stifel Nicolaus & Co.

Robert Lee – Keefe, Bruyette & Woods

Craig Siegenthaler – Credit Suisse

Alex Blostein – Goldman Sachs

Michael Kim – Sandler O'Neill

Cynthia Mayer – Bank of America/Merrill Lynch

Michael Carrier – Deutsche Bank

Roger Freeman – Barclays Capital

Douglas Sipkin – Ticonderoga Securities

Mike Holton [ph] – The Boston Company

Operator

Welcome to the Legg Mason’s first quarter earnings 2011 conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Alan Magleby, Head of Investor Relations and Corporate Communication for Legg Mason. Thank you. Mr. Magleby, you may begin.

Alan Magleby

Thank you. On behalf of Legg Mason, I would like to welcome you to our conference call to discuss operating results for the fiscal 2011 first quarter ended June 30, 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 condition and results of operations in the company’s annual report on Form 10-K for the fiscal year ended March 31, 2010 and in the company’s quarterly reports on Form 10-Q.

This afternoon’s call will include remarks from the following speakers, Mr. Mark Fetting, Chairman and CEO, and Mr. Terrence Murphy, Legg Mason’s Interim CFO, who will discuss Legg Mason’s financial results. In addition, following the review of the company’s quarter, we will then open the call to Q&A.

Now I would like to turn this call over to Mr. Mark Fetting. Mark?

Mark Fetting

Good afternoon. And thank you for your interest in Legg Mason. Today we will walk you through our results for our first fiscal quarter. We delivered a solid quarter in a volatile market, with more work to do to fully position Legg Mason for future growth. We have made considerable progress on our streamlining plans and we are on track to meet our targets. Joe Sullivan, our Chief Administrative Officer, has been working closely with our affiliates on transition plans and he is available to answer your questions later.

During the quarter, the markets had another strong pullback. In July, the markets have continued to have significant swings, both positive and negative. While the volatility presents challenges, it also presents opportunity. Our investment managers see value in what they view as quality investment opportunities in a market in which investors have once again pulled back from risk.

In fact, let me step back and speak to the markets from a client perspective, whether an institutional or individual investor. In the US, we believe the most likely scenario is that we are in a fragile recovery. In the words of our Small Cap Manager, Chuck Royce, we are looking at a ragged recovery. All of our managers agree a recovery stock market will be critical to restoring consumer confidence and consumption.

Outside the US, we see particular importance in China where it appears that policymakers are navigating a soft landing. Even with structural and sovereign debt issues to solve, we believe that related investment opportunities exist in Europe. Emerging markets continue to be attractive in the long-term, although as they are more correlated to the US and China, the ripple effect of these big two countries, positive and negative, need to be watched. We do not see the most worrisome combination of a double dip in the US and a hard-landing in China. As a result, we believe investors can take advantage of this excessive fear factor and pursue attractive investments through our proven managers.

Let’s begin with our highlights for the quarter on slide two. As I said, we are streamlining our business model though the real financial impact will hit in later quarters. Our work is progressing, and we continue to balance between goals of getting this process completed expeditiously and ensuring we get the transition right for our clients and our affiliates. We had a highly successful launch of the new closed-end fund, the ClearBridge Energy MLP Fund, which is the largest closed-end fund raised since 2007. We believe that this is an indication that there is an appetite for innovative products.

We executed a successful repurchase of our shares, reducing our shares outstanding by 6% to 154.5 million, with potentially more to repurchase as we complete an accelerated share repurchase arrangement. I am pleased to report that we had equity inflows in the quarter for the first time in four years. We reported net income of $48 million or $0.30 per diluted share and adjusted income of $96 million or $0.60 per diluted share.

We go to slide three, which show graphically our streamline business model, which we first introduced to you last quarter. First and foremost is our affiliates. We are a multi-manager model with our affiliates delivering customized investment solutions. Our streamlining is designed to eliminate redundancies between corporate and the affiliates. Corporate will focus on distribution, capital allocation, and investments to drive growth, whether that is new investment town talent or seeding new products. With a strong balance sheet, we are well positioned to do that.

The distribution platforms we have built have compelling value, and we expect to build on our momentum. The investments we have made in the Americas and international retail distribution are paying off, and we believe the infrastructure is capable of supporting substantially increased volumes. It will be an important component of growth for us. We believe that delivering client value will drive shareholder value.

Slide four shows there are assets under management. We ended the quarter at $645 billion, with 24% in equity assets, 56% in fixed income, and 20% in liquidity. Slide five shows our net flows. Overall, long-term net flows continued to trend favorably. As I mentioned a moment ago, we are announcing the first quarter of positive equity flows in over four years, driven by the closed-end fund and positive flows that many of our equity affiliates, including Batterymarch, Permal, Global Equities, and Royce.

Fixed income net outflows were $9.4 billion, up from the prior quarter, which I will discuss in more detail a bit later. Liquidity outflows picked up this quarter. Over the past three quarters prior to this, we have performed better than the industry in terms of flows. In this quarter, we did a bit worse.

If we shift to slide six, give an update on our performance, the percentage of our long-term fund assets that are beating their Lipper category averages as of June 30 are highlighted. As you can see, near-term performance has pulled back a bit, particularly after the market turmoil in May. However, our three and five-year numbers continue to improve over the year-ago period. We believe our short-term equity performance reflects the volatility in the marketplace.

After a tough couple of months in May and June, many of our managers made up significant ground in the first half of July and given back some over the last week or so. Fixed income performance held up well at both Western and Brandywine. This is particularly noteworthy in Western’s case, as they are a manager utilizing a credit capability among their strategies.

They attribute continued solid performance in this volatile second quarter to de-risking of portfolios begun earlier in the year. While one quarter does not make a trend, we think this is an early indicator that the adjustments they made in integrating their risk and investment functions with the right ones.

Slide sevens speaks of our assets under management by affiliates in order of their contribution to earnings. First let’s focus on Western at $457 billion. A big driver of Western’s decline in AUM this quarter is due to money market outflows. As we have pointed out in prior quarters, we have been waiving fees on most of these assets.

We also noted that Morgan Stanley Smith Barney has made a decision to convert the retail liquidity sweep suite business that we manage for them to their proprietary platforms beginning in 2011. This will include $23 billion in assets or approximately plus-15% of our total liquidity business. The financial impact to Legg Mason and Western Asset is minimal, as a large portion of these assets are having some of their fees waived in this low rate environment.

As we know well, flows follow performance. One of the things we have learned is that given the volatility in ’08, consultants and clients may be waiting a few more quarters to evaluate Western’s performance. As I mentioned earlier, they have so far displayed far less volatility in the recent tough market, and we think a continuation of that trend will have a positive impact.

Indeed, the performance improvement at Western is profound. Overall, the tone that we hear from consultants and clients is that interest in Western is back. RFP activity is up 20% since the end of ’09, and the total number of wins in the first half of this year is approximately the same as in all of ’09.

Having said that, there are pockets of redemptions, which do persist. In Japan, clients seeking higher incomes are shifting from global sovereign portfolios, a higher yielding multi-currency options, and Western is sharing in both the pluses and minuses of that shift, importantly, with the net plus on the side of fees of this equation. Core and Core Plus are seeing good, and in some cases, very big wins, but also saw expected departures reflecting decisions made earlier in the year. Western continues to see interest in corporate credit, local currency bond, and municipal bond capabilities.

Permal ended the quarter at approximately $18 billion, with net inflows for the quarter, while the hedge fund of fund industry continues to be an outflow. Their inflows include a $300 million mandate from a large sovereign wealth fund and $250 million in a large insurance mandate. They are seeing interest across their capabilities with tactical allocation and advisory work, offsetting softness in the traditional hedge fund of fund sector.

Permal continues to build up its buy side separately-managed account business, which now accounts for over $4 billion of its assets with 64 managers. Permal is very much a market leader in this field, a development that gives their clients additional liquidity, transparency, investment flexibility, and fee benefits. Relative performance across their products were strong, though difficult markets impacted absolute performance. Performance fees accordingly were down for the quarter, reflecting these difficult markets.

ClearBridge’s assets declined to $47 billion, due primarily to market depreciation. As I mentioned earlier, our distribution team in ClearBridge weighs $1.3 billion, assuming full exercise of an over-allotment option in the ClearBridge Energy MLP Fund. This was also a significant opportunity to introduce ClearBridge to new distributors. Of the tickets that were dropped in the fund, 50% came from advisors who have not done business with ClearBridge before.

Royce at $31 billion had slightly positive flows for the quarter, their sixth straight quarter of positive flows, continuing strong leadership in the small cap space. At Legg Mason Capital Management, assets declined to about just under $15 billion with the predominant cause being market depreciation. While five out of six flows representing approximately 50% of their US fund assets are outperforming their benchmarks on trailing one year performance year-to-date was negatively impacted in the final two months of the quarter.

Next is Brandywine, it is approximately $29 billion, down primarily due to market activity. After a tough ’08 and outperformance in ’09 in the first half of this year, fixed income performance in their largest mandates significantly outperformed over the one year period. A sub-advisory mandate in diversified large cap value that we won in partnership with them in December has now grown over $700 million in just six months. Japan and Australia have been good markets for their global fixed income products, and they are looking to expand upon that interest with significantly improved distribution capabilities out of their London office.

Finally, Batterymarch closed the quarter at about $19.5 billion. Despite assets being lower due to market action, Batterymarch saw net inflows for the quarter, driven by significant investments in their emerging market product from sovereign clients and new contributions from existing clients across accounts. Deferred account flows continue to show improvement, as withdraws and terminations are stabilizing.

Now shift to distribution, on page eight, we show our Americas distribution flow trends. Compared to June of ’09 quarter, net inflows have improved by 78%, reflecting both an increase in sales and lower redemption rates. The unit returned to slight outflow this quarter. This was partly due to two large insurance reallocations and allocations away from two of the products at large brokerage firms.

This was the top quarter in gross sales for Americas distribution since the second quarter of fiscal ’08 and the second consecutive quarter of positive flows for the retail scheme within this operation. And we continue to diversify our sales channel. The Independent Advisor Channel has grown to 26% of our retail sales, up 5% over the past year, while sales in the National Broker Dealer Channel are now split approximately 50/50 between our traditional relationship with Smith Barney and other firms.

Turning to slide nine, we are pleased to report continued momentum in our international distribution channel. Long-term net flows have increased over each of the past six quarters, with $2.8 billion in net flows this quarter alone. When you compare last quarter to the large year-ago period in ’09, sales have increased nearly 140%. Flows were led by Japan, followed by Europe, and were positive across nearly all of the regions in which we have a presence.

Flows continue to be predominantly driven by fixed income, particularly investment grade bonds and Brazilian and Australian denominated bonds. At some of the cost order funds we launched in ’08 and ’09 established track records. We are also seeing an increase in flows into those products. As we continue momentum, we look at ways to expand our presence in key markets.

And now let me turn it over to Terrence Murphy who is our Interim CFO. Terrence has been the Chief Operating Officer at ClearBridge since the Legg Mason-Citigroup transaction, and immediately prior to that, he was the Chief Financial Officer of Citigroup Asset Management. He has more than 20 years of financial and industry experience, and his experience working with our largest equity affiliate will be invaluable to me and the management team as we work through this transition. We deeply appreciate of Terrence stepping in and already doing so fine a job.

Terrence Murphy

Thank you, Mark. With regards to the first fiscal quarter of 2011, we achieved solid results in somewhat choppy markets. Revenues were slightly higher, offset by increased costs associated with the highly successful ClearBridge closed-end fund launch and mark-to-market losses on seed investments driven by equity market declines. With that, there are some more detail on the quarter’s results, which you could see on slides 10 and 11.

Net income was $48 million or $0.30 per diluted share, which includes an $18 million or $0.07 per diluted share impact of costs associated with launching the closed-end fund. In addition, this quarter we had $3 million in transition-related compensation and other costs or $0.01 per diluted share related to our streamlining effort. We will start to see more material numbers are related to this effort in the coming quarters, which will be reflected in our GAAP financials.

Operating revenues were up slightly this quarter despite a 2% decrease of average AUM, reflecting higher realization rates driven by lower fee waivers, high average AUM at several of our higher yielding equity affiliates, and an additional day in the quarter. Fee waivers this quarter were $5 million lower than the prior quarter. We also generated $23 million in the performance fees in fiscal Q1 and that is only slightly lower than last quarter’s fees. This quarter’s performance fees were driven by Western and Brandywine.

Operating expenses were up 1%, primarily due to the closed-end fund cost. As reported last quarter, we had a net settlement reserve of $13 million, partially offset by an $8 million lease recovery. Adjusted income was $96 million or $0.60 per diluted share and also included the $0.07 per diluted share charge related to the closed-end fund and the transition-related cost of $0.01 per diluted share.

Operating margin as adjusted was 20.9%. But when you add back the impact of the fund launch process totaled 2.9%, it puts us in line with last quarter’s adjusted margin. You will also note that on a GAAP basis our tax rate jumped from 36% to 38%. This is entirely driven by the consolidation of investment vehicles, primarily the result of FAS 167, which for us was effective on April 1 and is reflected as a separate non-operating income line for the first time in our financial statements. You could see the effect that’s had on our GAAP financials and the reconciliation scheduled in the appendix of this deck. Note that there is no impact to Legg Mason’s net income.

With regard to the expenses on slide 12, you can see that the only significant increase for the quarter was the closed-end fund cost, which impacted the compensation and benefits line, as well as the distribution and servicing line. The remaining expense lines were normalized with some of last quarter’s unusual events, including the lease recovery and the settlement reserves, are flat or slightly lower.

Drilling into the compensation and benefits expenses on slide 13, you see that the transition costs and mark-to-market on the deferred comp and seed investments basically offset each other. So the comp benefit ratio was 55%, both before and after these adjustments. However, the closed-end fund launch costs impacted the numerator and the denominator of the comp benefit calculations, increasing the result by 200 basis points. Excluding the closed-end fund related expenses, the comp benefit ratio would have been in line with our guidance or targeted range.

On slide 14, our operating margin as adjusted came in at 20.9%, but our margins were also affected by the closed-end fund expenses. The impact of this charge was 2.9%. And if these costs are excluded from the margin calculation, our adjusted margin would have come in slightly higher than last quarter’s 23.3%.

With regard to the balance sheet on slide 15, because of our strong cash position, we announced the stock repurchase last quarter. You could see the impact on our balance sheet as our cash balance is reduced by approximately $300 million and our shareholders’ equity is down as well. Our total cash is $1.2 billion, and our cash position net of working capital is close to $800 million.

As mentioned earlier, we have to consolidate certain investment vehicles for FAS 167. This impacted both assets, liabilities and stockholders’ equity by $386 million. And finally, despite the decrease on our quarter-end equity due to stock repurchase, our debt-to-total-capital ratio came in at 20% this quarter, in line with last quarter’s number.

On slide 16, we have provided some additional color around the accelerated share repurchase we announced last quarter. In the quarter, there were separate repurchase events. On May 21, we repurchased approximately 500,000 shares in an open-market purchase, and on May 24, we entered into an accelerated share repurchase. As a result of this ASR, on June 21, we retired an additional 9.2 million shares. These repurchases are reflected in the quarter-end share count, and the average share count was 1.2 million shares lower.

The full benefit will not be reflected in our average shares until next quarter. We may retire additional shares under the ASR before September 30 based on the weighted average price over that period depending on our counterparty trading activities. At the current stock price, we could see approximately 1 million in additional share repurchases by September 30.

On slide 17, I want to provide an update on the streamlining efforts we announced during last quarter’s earnings call. As Mark mentioned earlier, Joe Sullivan, our Chief Administrative Officer, who is overseeing the transition, is here in the room and is available for any questions you may have. The transition is well underway, and implementation began July 1. Right now, we are on target to achieve our goals in terms of expense savings and restructuring costs related to the transition.

Following the Investor Day, Mark and I spent time reaching out to investors regarding the streamlining effort and clarified our plans following our announcement. As we have indicated, we expect to achieve $130 million to $150 million increase in shareholder value on a run rate basis by the fourth quarter of fiscal 2012. Included in these savings are corporate and distribution expense reductions of approximately $50 million, a transfer of or charges for activities related to the affiliates of $75 million, and an increased sharing of retail revenue based on new AUM of $15 million.

With regard to the $75 million in services the affiliates will pick up, the early work done by the affiliates indicate that they will be able to absorb these services at a meaningful reduction in total cost. We also expect to incur approximately $125 million to $135 million in restructuring and related costs as well as $75 million in costs related to the transitional support for the affiliates.

I want to remind you that the bridge offsets the impact to the affiliates of the parent [ph] charging for its services and most of the bridge costs will be incurred over the next four quarters. This quarter, we had approximately $3 million in transition-related compensation and other charges, and in fiscal second quarter, we are expecting approximately $15 million in transition-related comp costs.

Before I turn it over to Mark, I would like to say I look forward to working with Mark and the finance team through the transition while we search for a permanent CFO. With that, I’d turn it back over to Mark for his closing comments before we go to Q&A.

Mark Fetting

Before we open it up for questions, I want to summarize where Legg Mason is going. After our announcement in May, we have been working extensively with our affiliates and operational teams on streamlining our business model. Our implementation plans are in place, and we are on track to meet our goals.

We are partnering with our affiliates on performance, retail distribution, and investing with them to grow their franchises. We are actively evaluating ways to enhance growth through lift-outs, bolt-ons and seed investments in new products. And we are effectively deploying capital, as you saw, through the accelerated share repurchase completed this quarter.

I thank you, and we welcome your questions.

Question-and-Answer Session

Operator

(Operator instructions) Our first question is coming from the line of Mr. Bill Katz with Citigroup. Your line is now open. You may proceed with your question.

Bill Katz – Citigroup

Okay, thank you. Good afternoon, everybody. Just going back to Western Asset Management for a moment, I’m sort of wondering if you could sort of size pool of risky assets still that might be facing some outflow and you still feel confident that you could turn that business positive by the second half of the year.

Mark Fetting

Thank you, Bill. I think we feel very good about the momentum we’ve got underway. And I would say absent the market conditions, we feel good about our goal of kind of what the management team has said about the second half of the calendar year. At the liquidity piece, obviously we have communicated some specific issues there. So I think we should keep the liquidity piece separate. And specifically I’m speaking to the retail sweep business that’s kind of underway. And then the other piece is probably flows don’t tell the story relative to revenues if you look at something like what’s going on in Japan and the kind of income shift from global sovereign to these multi-currency products on a flow story that’s probably a negative, but on a revenue basis, it’s a real opportunity for us.

Bill Katz – Citigroup

I guess my follow-up is on capital. You seem like you're still pretty flush of capital. Stock is sort of right where it was in May with your first buyback. Could you sort of prioritize the thought of acquisition versus, I guess, in the press release you alluded to just being interested in doing acquisitions and other growth vehicles? Maybe help us understand the priorities for capital?

Mark Fetting

Yes. I think our general priorities are consistent with what you’ve heard. Certainly, as we indicated, the Board authorized a $1 billion multi-year buyback program. And while we have stepped up and are kind of active at the momentum in concluding the first $300 million of that, we will continue to monitor conditions on all the tests that you would want us to. In addition to that, we feel good about the fact that we’ve got – we think the business is growing well, and our priority near-term is more on the bolt-ons and lift-outs and anything more meaningful. So I think we will continue operating on both fronts, but clearly with the opportunity to continue to buy back some stock if circumstances justify.

Operator

Thank you. Our next question is coming from the line of Mr. Dan Fannon with Jefferies & Company. Your line is now open. You may proceed with your question.

Dan Fannon – Jefferies & Company

Good afternoon. Can you guys discuss a bit about the pipeline? I mean, you did a nice job talking about flows in the quarter. But as you look at this quarter and maybe a little bit further out, where the backlog sits and specifically if you could talk about Permal and think about kind of the next three to six-month outlook there as well?

Mark Fetting

Yes. On the pipeline, as we mentioned, with both Western and Brandywine in the fixed income area, it’s a very attractive situation with a growing pipeline. In Permal, it is particularly so, as particularly on the institutional side of the business, there is an increased appetite for proven managers in the space. And Permal has won some significant mandates and is poised, we hope, to actually increase that trend. I’d say on the broader equity front, it really kind of – there has clearly been a bit of a pullback in both – certainly you see it in the retail data with mutual funds, but you see it not necessarily a decrease in, let’s say, interests, but I think in pulling triggers, people are a little pausing right now on the equity front. But the specific areas that we see activity and have done well would be emerging market equities at Batterymarch and our London team, and also an opportunity in the shift from small cap to large cap, some interest in some of our other managers.

Dan Fannon – Jefferies & Company

Okay. And then more of I guess a modeling question. First, with regards to the sweep outflows, you said 2011; I assume that’s your fiscal year, so beginning here in the next couple quarters. And in thinking about the realization benefit you got this quarter from decline in money market fee waivers, should that offset as those assets go out the door and we should the benefit from those money market fees actually coming back just be more muted? Trying to get a sense of, from a modeling perspective, the sustainability of the realization rate at these levels and then also the timing of the rollout of the sweep funds.

Mark Fetting

Yes. On the fee side, clearly it’s interesting if you look at short rates, they kind of came up a bit, which gave I think all of us in the industry an opportunity to reduce those fee waivers, and then they came back down. To the extent rates rise just a bit, that’s favorable for reducing the fee waivers. Obviously, one of the benefits in kind of a counterintuitive way of having fewer liquidity assets is fewer waivers. We are not happy about that. But we do expect this roughly $23 billion to go sometime in the fourth quarter of fiscal year. And that we think is, as you know, from priorities kind of really at a minimal impact in terms of bottom line to either Western or us.

Operator

Thank you. Our next question is coming from the line of Mr. Jeff Hopson with Stifel Nicolaus & Co. Your line is now open. You may proceed with your question.

Jeff Hopson – Stifel Nicolaus & Co.

Okay. Just a follow-up on the numbers a little bit. How much was the benefit on the fee waiver side? And was that by itself the biggest driver in the fee rate of the fund fee rate increase or did Permal also have an effect on that?

Terrence Murphy

The fee waiver has a total of $5 million impact from a revenue perspective. So revenues better by $5 million drove by the fee waivers. The second biggest driver of that though is really the higher yielding equity products at one of the affiliates so that that higher yielding number is actually driving the revenues up.

Mark Fetting

And Jeff, I would say, I don’t have the exact data to link it, but certainly Permal having positive flows and being one of our higher fee pieces is a plus. And then of course, Royce continuing to grow nicely even in this volatile market. You have two kind of higher fee managers there swinging it.

Operator

Thank you. Our next question is coming from the line of Mr. Robert Lee with Keefe, Bruyette & Woods. Your line is now open. You may proceed with your question.

Robert Lee – Keefe, Bruyette & Woods

Thank you. Good afternoon, everyone. Just a question, if you could maybe just break down the closed-end fund question, a little bit of geography, kind of how much was in comp and how much was in distribution or other expenses?

Mark Fetting

I’ll let Terrence hit this, but let me start because I’m biting my lips here – my tongue I guess these days. The reality is you have a little bit of a mismatch going in the quarter. In terms of GAAP requirements, we are front ending the full expense of launching the product with almost zero revenue impact. And the revenue impact will start in the next quarter, because at this point, we’ve funded it, we’ve invested it more earning our full fee. And of course, those costs are behind us. So that $0.70 I think really should be properly adjusted is kind of thought one. Terrence?

Terrence Murphy

Yes. For distribution and servicing, there is $14.8 million of costs there. And then there is another $2.8 million in compensation.

Operator

Thank you. Our next question is coming from the line of Mr. Craig Siegenthaler with Credit Suisse. Your line is now open. You may proceed with your question.

Craig Siegenthaler – Credit Suisse

Thanks. Good afternoon, everyone.

Mark Fetting

Good afternoon.

Craig Siegenthaler – Credit Suisse

Just to hit again on the money market business with Smith Barney there; is this a beginning of a trend in terms of redemptions in money market funds back towards capital distribution platform such that they have those capabilities? Should we see additional maybe money market business being lost at Smith Barney? And could some of the other big platforms do this too?

Mark Fetting

I obviously can’t speak for other firms, but I will say in this case I think it’s very specific to a decision by Morgan Stanley to sell a piece of their asset management business, but to retain another, and then with the joint venture being formed between MS and SB, a decision to kind of consolidate that. We have a great relationship with the firm and are working hard to offset that with other business opportunities within the system. I think on a broader basis, with the money fund business being what it is, that most of the others probably have lined up, but I can’t speak to that specifically. This is the one where we are involved in a retail sweep and the only one.

Craig Siegenthaler – Credit Suisse

And just to clarify on the buyback assumption, after September, is there roughly about $680 million left to repurchase stock after the additional 1 million you talked about in September?

Terrence Murphy

Correct.

Craig Siegenthaler – Credit Suisse

Okay, great. Thanks for taking my questions.

Operator

Thank you. Our next question is coming from the line of Alex Blostein with Goldman Sachs. Your line is now open. You may proceed with your question.

Alex Blostein – Goldman Sachs

Hi, guys, thanks. I want to circle back to the streamlining expense that you guys outlined. So it looks like you are taking out a couple of millions or $3 million yourself from the run rate this quarter, but it’s not really clear I guess how much of a benefit you are getting. So question one, I guess, can you quantify how much of a benefit you are getting on the cost side this quarter? And then maybe just kind of a trajectory of the $130 million to $150 million of savings you expect to save in the next couple of years?

Joe Sullivan

Alex, this is Joe. Consistent with what we said at Investor Day, you’re going to see and we’re confident to kind of confirm that the $130 million to $150 million will be a run rate margin improvement by the fourth fiscal quarter of 2012. So that’s the quarter ending March 31, 2012. You will see that in the run rate at that time. It’s going to be lumpy along the way. There was a modest charge associated with the streamlining this quarter, and it will be a little bit before you see it, you’ll start to see it lead in a little bit next quarter and ongoing every quarter. But effectively, the bulk of it or the run rate will be achieved in that fourth fiscal quarter.

The only other things as it relates to Investor Day and the numbers that we’ve presented at that time is that we’ve spent the last two months or so in a really very detailed planning process. And as a result of that, we’ve pushed a little bit, about $15 million to $20 million of the costs and charges from fiscal 2011 to fiscal 2012. And that was just the result of getting a lot more granular over the last two months in the planning process. But that’s $15 million to $20 million shift from fiscal ’11 to fiscal ’12, and that’s on a total restructuring and cost charge basis of about $200 million.

Operator

Thank you. Our next question is coming from the line of Mr. Michael Kim with Sandler O'Neill. Your line is now open. You may proceed with your question.

Michael Kim – Sandler O'Neill

Hey, guys, good morning. Just to follow-up with the last comment in terms of the shift in costs out to fiscal ’12, does that imply that an equal portion of cost savings will be pushed out into next year as well?

Joe Sullivan

No. I would say that our cost savings are about consistent with what we’ve projected on Investor Day, but it’s just that some of the charges associated with them, about $15 million to $20 million will be pushed into ’12. But the actual saves that we realize along the way are not materially different. Mix is a little bit changed here and there, but the overall margin improvement that we expect over the course of the next couple of fiscal years does not change materially.

Operator

Thank you. Our next question is coming from the line of Cynthia Mayer with Bank of America/Merrill Lynch. Your line is now open. You may proceed with your question.

Cynthia Mayer – Bank of America/Merrill Lynch

Hi, good afternoon. Just going back to Western, I think you mentioned that Core and Core Plus are still seeing some outflows from some previous decision. So can you give us a sense of what the outlook for flows is now based on decisions you already know of? And also, how large are those strategies at this point? And finally, I think you mentioned that risk management changes have been helping in terms of retaining clients. Which products do you think it’s been – those have been most helpful in retaining clients in?

Mark Fetting

Well, let me start with the latter half of that, Cynthia, in terms of the risk management piece. Western went out with a letter just I think about a week ago from Jim Flick, the Head of their Client Service activities, detailing a series – comprehensive kind of updates. And you can really see there that the deployment of a Chief Risk Officer and kind of overseeing across the way they invest – across the board the way they invest has been very helpful. It’s allowed them to stay true to their philosophy and process around essentially a valued investor with among other capabilities of credit orientation, but they have certainly kind of been more sensitive to the risk aspect of that and customize it with clients. I think that’s been across the board.

Specifically, in terms of the Core Plus, I mean, it remains an important, but as I’ve said to many of our shareholders in meeting with them recently, Western is a much more diversified firm than people expect. This would still fall in probably somewhere in the plus-20% range of their total assets, an important area accounting both Core and Core Plus, but at the same time, significant growth in global credit, in munis, and other initiatives that they have underway, whether it’s emerging markets or high yield etc. Now, what’s interesting is this issue of a year ago we weren’t getting many wins in the Core, Core Plus area, and we are getting some very attractive wins now funded across the board and we’re getting a lot more interests offset against that and currently still a bit of a minus, are some preexisting. We’re hopeful that that inflection point is going to be achieved in the second half, which along with the growth in some other areas should make for a good second half, subject to again the market conditions and what’s going on overall.

Operator

Thank you. Our next question is coming from the line of Mr. Michael Carrier with Deutsche Bank. Your line is now open. You may proceed with your question.

Michael Carrier – Deutsche Bank

Thanks, guys. Just one question on the target margins in the streamlining, I think when you look at timing in terms of the assumptions and based on how the markets are, how sensitive are those synergies to the environment? And if you have to extend the bridge or if it does take some amount of time, just what do you think the impact is to you in the interim until you achieve those margins in 2012?

Mark Fetting

I think as I said early on, I think we went through this in Investor Day. We really stress tested this, and we are not in an environment now that would alter our expectations. So, absent this going back low probability – I guess there is a probability of the double whammy of a real recession, double-dip in the US, hard-landing in China, etc. If you pull all those things together, we still think we capture most of it, but not all of it. We are not in that environment. In this environment, we feel good about it.

And one of the reasons it is important to recognize when we talk about $130 million to $150 million of kind of earnings improvement on a run rate basis that $50 million of that is coming from corporate initiatives, $75 million is coming from services that we now deliver on our cost base that we are passing on to the affiliates over this one year transition. And we are very encouraged in terms of the underlying activity there. In fact, Terrence, you might hit that just with a couple examples at ClearBridge. And then finally, there is the $15 million piece is coming from distribution recovery. So there is multi-pieces to it that give us confidence, kind of tough environment scenario as an extreme. And it’s spread across all the managers, so we feel solid right now. But Terrence, talk about some of the activities you see.

Terrence Murphy

Specific to ClearBridge, one of the things that we are seeing is that – one of the things that I don’t think is broadly understood is that there is already some level of operations and technology folks embedded in each of the affiliates. And that really varies by affiliate. So some of the expertise is already in house. And then as it relates to vendors and trying to outsource some of the activities or renegotiate contracts, we are having great success in those conversations and we are seeing a downward view on expenses as we go through the planning stages and working through the vendors on the long-term costs that are going to be associated with this going forward. So we are quite pleased that we are able to utilize the staff that’s already embedded in ClearBridge, and the transition is going extremely well as it relates to talking with vendors, as we get through this process.

Joe Sullivan

Yes. And I would just say, it’s really important to remember that – we talk about this $75 million that we spent corporately that will be activities that will be transition to the affiliates. Number one, that’s our spend that, as Terrence just alluded to it, clearly very clear to us that the affiliates are going to be successful in reducing that spend on an individual level. And then you have to remember that this is spread out over 12, 13 different affiliates. So – and then to Terrence’s other point, just to reiterate, our model has long been that many of the support people in our technology operations platform and other finance and legal have been embedded in the affiliates. So this hand off is really I think going to be a remarkably smooth one.

Operator

Thank you. Our next question is coming from the line of Roger Freeman with Barclays Capital. Your line is now open. You may proceed with your question.

Roger Freeman – Barclays Capital

Thanks. Good evening.

Mark Fetting

Good evening.

Roger Freeman – Barclays Capital

I guess just coming back I think some of these questions around the – some of the notices that came in at different periods, if you would sort of recast the March quarter and the June quarter of fixed income flows, the $8 million outflows and $9.4 million in the June quarter and show it as if all – any redemption notices came out during those same periods, how would that look? In other words, would it be less this quarter? Does it make sense what I’m asking?

Mark Fetting

Yes, keep going, keep going, if you don’t mind. Get clarified because I want to be –

Roger Freeman – Barclays Capital

If you just count all outflows as happening in the period in which they are actually – you are getting notice as opposed to in the June quarter you’ve got apparently some amount that came through that was actually you got the notice for last quarter.

Mark Fetting

Yes. I think basically our watch list, if you will, declines, continues to decline and meaningful. It varies mandate-by-mandate, capability-by-capability. And the places that we are monitoring and working hard on most, as I said, would be in kind of the Japan piece where we’ve got good product offset there. And then I guess on the Core, Core Plus side, we are gratified to see much lower number of names in the watch list. And offsetting that is a very nice inflow. The net, we hope, moves past this inflection point. But I think the most specific answer to your question is the watch list is declining meaningfully.

Roger Freeman – Barclays Capital

Okay. And then I guess the follow-up, slightly separately, you mentioned that you had a – if you look at your flows this year, it says it’s 5% increase and flows to independent advisors versus I guess national – I guess the warehouses. Was that a function of the advisors being more aggressive in allocating clients into fixed income or is that you signing up more advisors relative to –?

Mark Fetting

Really it’s – it is certainly the latter in terms of we continue to have a strong trend of new advisors writing tickets on Legg Mason related products for the first time. We have a very clear strategy under our team in the Americas side around building now the independent channel and then building out within what we call the National Broker Dealer Channel beyond just our historic relationship with Smith Barney. That’s a 5 percentage point increase, by the way. So it’s really – if you look at the diversity of our distribution today, and I think we updated that at the Investor Day, but even this quarter you would see continued improvement, and I underscore the benefit of CEM, as we call it, the ClearBridge Energy MLP ticker is CEM, for those interested. The number of people writing tickets for the first time, it was a great vehicle that attracted a lot of interest that’s new to ClearBridge and new to Legg Mason, and that can only pay even better dividends.

Operator

Thank you. At this time, we only have time remaining for two further questions. Our next question is coming from the line of Mr. Douglas Sipkin with Ticonderoga Securities. Your line is now open. You may proceed with your question.

Douglas Sipkin – Ticonderoga Securities

Thank you and good afternoon. And thanks for taking my question. Just trying to drill down a little bit on the cash that you guys provided in the PowerPoint. I noticed it declined by roughly I guess the amount of the buyback, and I’m just wondering what else was going on in the cash this quarter. I would have expected to see a little bit higher based on sort of your adjusted income. And then just one follow-up.

Mark Fetting

Yes. I think we are actually consistent on this in terms of the cash piece. Terrence, you want to –?

Terrence Murphy

Right. It’s the bonus payout that which happens here during the month of May. So why you don’t see it going and why the only change is the $300 million, it’s related to the – the income is being offset by the amount of the payout.

Douglas Sipkin – Ticonderoga Securities

Got you. So that’s sort of like a seasonal thing now happened in the first quarter of every year?

Terrence Murphy

Yes.

Douglas Sipkin – Ticonderoga Securities

Okay. And then just a follow-up. I noticed you guys change sort of the name of the non-GAAP measure from cash to adjusted income, and I’m just wondering what was the rationale behind that. Thanks for taking my questions.

Terrence Murphy

I think – we believe that it is beneficial to provide a supplement to GAAP, and I think there is some discussion among SEC and others around the use of case as appropriate as a performance measure versus liquidity measure. So in light of that, we made an – we just changed to adjusted income. It’s the same measures. And that’s the reason.

Operator

Thank you. Our final question comes from the line of Mr. Mike Holton [ph] with The Boston Company. Your line is now open. You may proceed with your question.

Mike Holton – The Boston Company

Hey, just a follow-up question on one of the Western questions earlier. Mark, can you quantify exactly how much the watch list went down? You said materially, but some numbers would actually be helpful –

Mark Fetting

I don’t think we had given that level of detail, but just let me tell you what we do. And Western, I think, is traditionally and quite justifiably been seen as one of the best in the client service side of ht business. You just monitor relationships, and I’ll say it’s not just on the downside, but also the upside. And as they have tracked the key accounts, you are seeing something in the 40% range approximately. And within that base remains accounts that it’s not so much defensive. It’s just watching for opportunities to cross sell etc. So I think significant improvement against the continuing trend and real signs of positive offset or what we’re looking at there.

Mike Holton – The Boston Company

Okay. Let me just follow up then. I mean, as you can tell by a lot of the questions, excluding this one, I think people are continuously disappointed by the Western outflows. And given each quarter you all have a lot of very good reasons why it won’t continue, it always does. So if you think out next three quarters, you’ve talked about being hopeful of returning to inflows, but I think the only thing that seems to have changed is on the negative side with the Solomon Smith Barney/Morgan Stanley that will hit in Q4. So again, can you give any other tangible reason why you can actually get the inflows or even share with us what your assumption is for aggregate inflows or outflows between now and year-end for Western? Thanks.

Mark Fetting

Yes. Obviously I would take exception to some of the tone and direction of the question, because first and foremost, Western’s performance speaks for itself. It has improved and flows follow performance. In the midst of this improvement cycle from, let’s call it, kind of first quarter of ’09 to date, it’s been far from a V-shaped recovery in the market. And that has added, I think, some positive times reflection on the part of consultants and clients. At the same time, the reality is – and you can independently verify Western being kind of invited back and doing quite well with both clients and prospective clients. What we’ve tried to do is be as informative as we can around the diverse business of Western. And I think if you compare some of that with the industry as a whole and key competitors in that market, you’d find exactly the same dynamics.

There are some areas where we’ve clearly had some opportunity costs where others have benefited from this pursuit of fixed income, and we normally would benefit more if we didn’t have some of the legacy issues, but we are trending better and better. I wish I could be as specific as it’s going to happen in a month or two months, and I’m sure Jim Herschman and his team would be delighted as well. But I don’t think anyone has that ability. And hence what we can do is kind of identify the things that are working in terms of performance, the areas we’re getting inflows, the areas we’re being very straight up, we’re in other words [ph] continuing to get some outflows. We remain confident about the momentum and the opportunity to gain across the board like we are right now. And I look forward to continue to report results that are favorable on this fund so long as we have them to report.

Operator

Thank you. Ladies and gentlemen, we have reached the end of our question-and-answer session. I would like to turn the floor back to management for any closing comments.

Mark Fetting

I would like to thank everybody for their questions. It’s been a good discussion. And I want to reiterate my sense of where we are as a company in the turnaround at Legg Mason, I think we’ve delivered a solid quarter of results in a volatile market with more work to do and we’re going to do it. I thank you for your interest and look forward to keeping you posted on our progress. Thank you.

Operator

Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time. Thank you very much for your participation. Have a wonderful evening.

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Source: Legg Mason, Inc. F1Q11 (Qtr End 06/30/10) Earnings Call Transcript
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