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Legg Mason, Inc. (NYSE:LM)

F4Q14 Results Earnings Conference Call

May 1, 2014 8:00 am ET


Alan Magleby – Head of Investor Relations & Corporate Communications

Joseph A. Sullivan – President, Chief Executive Officer & Director

Peter H. Nachtwey – Chief Financial Officer & Senior Executive Vice President


Christopher Harris – Wells Fargo Securities

Robert Lee – Keefe, Bruyette & Woods, Inc.

Macrae Sykes – Gabelli & Company

Daniel Fannon – Jefferies & Company

Michael Kim – Sandler O’Neill

Craig Siegenthaler – Credit Suisse

[Unidentified Analyst] – Citi

Mike Carrier – Bank of America Merrill Lynch


Welcome to the Legg Mason fourth quarter and fiscal 2014 year-end earnings 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) Please note that this conference is being recorded. It is now my pleasure to introduce your host Alan Magleby, Head of Investor Relations and Corporate Communications.

Alan Magleby

On behalf of Legg Mason I would like to welcome you to our conference call to discuss operating results for the fiscal 2014 fourth quarter and the fiscal year ended March 31, 2014. This presentation may contain forward-looking statements within the meaning of the Private Securities Litigation Reform act of 1995. These forward-looking statements are not statements of facts or guarantees of future performance and are subject to risks, uncertainties, and other factors that may cause actual results to differ materially from those discussed in the statements.

For a discussion of these risks and uncertainties, please see risk factors and management’s discussion and analysis of financial conditions and results of operations in the company’s annual report on Form 10K for the fiscal year ended March 31, 2013 and the company’s subsequent filings with the Securities & Exchange Commission.

During the call today we may also discuss non-GAAP financial measures. Reconciliations of non-GAAP financial measures to the comparable GAAP financial measures can be found in the press release that we issued this morning which is available in the investor relations section of our website.

This morning’s call will include remarks from Mr. Joe Sullivan, Legg Mason’s President and CEO and Mr. Pete Nachtwey, Legg Mason’s CFO who will discuss our financial results. In addition, following a 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. Joe Sullivan.

Joseph A. Sullivan

As always, I appreciate your interest in Legg Mason. I welcome you to our fourth fiscal quarter and full fiscal year 2014 earnings call which concludes my first full year as CEO. Over that time I have been very proud to see our organization pull together and build momentum to better serve our clients and shareholders and to return the company to a position of industry leadership. A centerpiece of our efforts has been a number of actions to pursue growth and diversification and I and the rest of our executive team believe that the decisions and investments that we make today will have considerable impact on our growth prospects for 2015 and beyond.

Over the last 12 months, we have made meaningful progress on evolving our affiliate mix to create fewer and larger affiliates with recognized investment expertise. Our goal is to have a broader and deeper set of investment capabilities across Legg Mason’s affiliates while creating greater balance and diversification in our flows, revenues, and earnings. This quarter we announced the addition of some important capabilities, principally through QS Investors which I will discuss in a moment.

Of equal importance, we are reinvesting savings realized during the year and investing further to accelerate growth in our global distribution platform which is a key growth driver and a powerful differentiator for Legg Mason in the marketplace. To build upon the growth in distribution, we are making a number of thoughtful investments to enhance and expand our coverage of the intermediary channels. We have stated consistently that our distribution strategy is always going to be driven by the needs of our clients.

To that end, we are increasingly utilizing technology to target and better serve the needs of our clients and prospects with increased efficiency. We’re using big data to both drive our resource allocation decisions and better understand the business needs of the advisors we currently serve and those with whom we want to do business. I’ll talk more and Pete will add some additional detail about the rollout of this initiative a bit later.

As we look back over the year, our business mix improved across asset classes as equity markets strengthened and sustaining this mix shift is an area of great focus for us. To sum up the year, the strategic progress we’ve made against our initiatives in combination with a strong improvement in flows, as translated to solid financial performance versus fiscal 2013. It’s important to confirm that our number one priority going forward is growth. Sitting here today, I am confident that we are on the right path to deliver on our organic growth and position our shareholders for ongoing value creation.

Now, let’s talk about the results for the quarter. Net income for the quarter was $69 million or $0.58 per diluted share. In keeping with our ongoing commitment to return capital to shareholders, we repurchased two million shares for $90 million bringing the total repurchase during the fiscal year to 9.6 million shares and, as you saw earlier this week, our board authorized a 23% increase in our dividend. We are pleased that over the past there years the combination of our share buyback and dividend has resulted in Legg Mason delivering one of the highest total shareholder payout rates in the industry.

Our AUM ended the quarter at $702 billion. Long term flows were slightly negative with equity inflows offset by fixed income outflows driven largely by an increase in net redemptions in the low fee global sovereign mandate that we previously discussed. Net of that sovereign mandate outflow, we would have been positive in long term fixed income flows.

We are pleased that won but not yet funded mandates for the quarter remain solid at $7.5 billion. Offsetting that pipeline in April is a sub advisory reallocation outflow at ClearBridge and some expected outflow related to performance a Batterymarch and the pending combination of the firm with QS. The combined total of those outflows are approximately $1 billion.

Investment performance remains strong with three quarters or more of our strategy AUM exceeding benchmark for all time periods. We refinanced our debt, deleveraged our balance sheet, and locked in long term debt capital at current historically low rates. As I mentioned in the introduction, we announced the acquisition of QS investors to strongly position Legg Mason in the rapidly growing categories of global solutions, liquid alternatives, and smart beta. We believe that multi asset class allocation is a growing and enduring investment approach in which I am very confident Legg Mason can take a visible leadership position in the years ahead. Finally, we implemented a management equity plan for ClearBridge Investments providing both their management team and the Legg Mason shareholder upside as revenue and asset levels grow.

Slide Four is our standard presentation of AUM by affiliates. As we’ve reported, we experienced net inflows for the quarter driven by liquidity. Again, our primary focus as we begin the new fiscal year is to meaningfully and consistently increase net long term inflows. As we begin our new fiscal year and particularly because we’ve acquired QS Investors, we intend to modify our disclosure to begin reporting assets under advisement or AUA. We believe this change will be helpful to investors in understanding the makeup of our assets and flows.

As you may recall, QS Investors has nearly $100 billion in AUA. Our AUA will now include assets currently not reported in both Brandywine and ClearBridge’s AUM and some other AUA at Western including the low fee sovereign global mandate that we referenced for some time and which is currently reported in AUM. We believe that moving this global sovereign mandate to AUA better reflects the current contract Western has with that client.

Let’s start our AUM review with fixed income. We had outflows of approximately $900 million in the quarter from Western including $1.4 billion from the sovereign mandate. In what was a difficult last 12 months for fixed income across the industry, Legg Mason in aggregate, had total inflows of $1.1 billion for the year driven by Brandywine Global which was net positive at $3.6 billion. In addition, outflows from the sovereign mandate we’ve referenced total $4.7 billion in fiscal year ’14 without which Western would also have been net positive approximately $2 billion in long term flows for the year.

Both Western’s product development and flows over the fiscal year reflect the ongoing trend away from core products and into specialized or alternative credit strategies. The macro [ops] product Western launched for example, recorded sales of nearly $2 billion in a variety of vehicles by the end of the quarter and we’re seeing strong interest in the product continue. In addition, Western’s mortgage team has launched a number of products including two CLO products raising in excess of $1 billion.

Western recently won two advisory mandates to evaluate insurance portfolios and the growth of their business in the insurance channel continues. Won but not yet funded mandates at Western stood at $2.4 billion at the end of the quarter. Brandywine had net inflows of $500 million led by their equity strategies and assets under management grew to $52 billion, their highest level yet. Brandywine’s won but not yet funded mandates closed the quarter at $2.4 billion, the highest level for Brandywine since 2008 with the majority of those in fixed income.

Like the broader trend we see in fixed income the team at Brandywine also sees strong interest in absolute return products with nearly $400 million in flows for the quarter and more than $3.5 billion in those strategies at the end of March. Equity strategies at Brandywine also continued to perform well overall where net flow positive for the quarter and are increasingly drawing interest from a number of clients.

Moving onto our equity focused affiliates, inflows into equities during the quarter were led by ClearBridge with net inflows of $2.2 billion, the firm’s fifth consecutive quarter of strong net inflow. These positive flows were led by high active share products and to a lesser degree income solutions. Unfunded wins at the end of the quarter for ClearBridge stood at $1.2 billion.

By channel, ClearBridge has expanded its presence in the IRA and independent advisor channel while continuing to build upon its presence within the MDB channels. In addition to achieving diversification in the US markets, ClearBridge continues to expand its business geographically with solid sales results in Japan and Europe. Finally, ClearBridge completed the rebranding of Legg Mason Capital Management Funds into ClearBridge and the investment performance of those funds continues to strengthen.

Royce experienced outflows in the quarter that were in line with the December quarter. The challenges at Royce are consistent with what we’ve been saying for a while now, specifically that while modestly elevated, redemption rates are generally in line with historical trends. However, because of the company’s relative under performance, Royce is not currently screening well with advisors and therefore subscriptions are down.

To address this sales challenge, Chuck and our distribution team have kicked off a new marketing and sales campaign with a particular focus on visiting intermediaries at the home office and in the field, reinforcing Royce’s focus on quality and long term orientation. Relative investment performance improved markedly last quarter and Chuck continues to believe strongly that active management will ultimately prevail over passive investing in the small cap space.

Given the universe of illiquid under followed companies with greater price discrepancies within the index and a renewed emphasis by investors on fundamental operating performance as opposed to financial and balance sheet management, Royce sees a wonderful opportunity to highlight the critical differentiation and the importance of active managers from passive managers in the small cap space.

Finally, alternatives. Permal had slight outflows for the quarter although significantly improved from prior quarters. Outflows at the legacy Fauchier business have abated and the clients who remain are beginning to top up positions with Permal. Permal has now added Fauchier offerings to their managed account platform which represents a new growth opportunity for those products. The pipeline of won but not yet funded mandates ended the quarter at $800 million for Permal, some of which has already funded.

Permal’s managed account platform ranks fifth in the industry with over $8 billion in AUM and Permal is one of just two [bi-side] providers in that segment. As a [bi-side] manager Permal is more investment than distribution driven providing stronger due diligence and transparency. Permal continues to see strength globally in the institutional and sovereign wealth fund segments and importantly, the global high net worth segment which has driven outflows over the past few years, seems to be stabilizing. We also had success in getting Permal’s retail funds on platforms with our US distribution partners and we expect to see continued momentum in the US retail channel throughout the year.

Slide Five provides an overview of the acquisition of QS Investors which we announced in early March. The preparations for the combination of QS with Batterymarch and Legg Mason Global Asset Allocation are proceeding well. The transaction is scheduled to close at the end of May and we’ve completed the process of identifying those team members that will join QS Investors from Batterymarch and LMGAA.

Our belief at the onset of this combination was that the strategies and relationships at our legacy firms were highly complementary to QS Investors which has largely been borne out in our discussions with clients which I would characterize as quite positive. Indications around the retention of assets post announcement are trending well and are currently exceeding what we had modeled going into the deal. We’re very pleased that QS Investors continued to win business in the month since we announced the transaction suggesting strong client buy in to the potential of this new combination.

AUM for QS Investors at the end of March was nearly $5 billion, up from $4.2 billion at the announcement. With this combination under the leadership of QS Investors’ CEO Janet Campagna we will have a scalable platform that can compete for and win institutional custom solutions mandates while bringing those products to the retail marketplace.

Slide Six provides an overview of the management equity plan or MEP that we recently completed with ClearBridge. Like the MEP with Permal, this plan allows for the ClearBridge management team to share in the growth prospects of their firm and creates financial incentives for them to invest in long term growth initiatives. We believe this MEP will be an important vehicle for recruiting and retention and will support succession planning as both the current management team and the next generation of affiliate leaders will have a greater stake in creating and preserving long term franchise value.

So, let’s walk through the highlights of the plan. Equity plan participants will have the opportunity to share in 15% of the incremental growth of enterprise value from the date of plan inception. We expect the initial charges to Legg Mason from the equity awards to be less than $2 million per year over the five year vesting period as we and ClearBridge share equally in the plans annual expense. The plan includes the flexibility to include future hires and our shareholders will benefit from a progressively higher revenue share on incremental growth.

Slide Seven is our standard presentation of investment performance. Strategy AUM performance against benchmarks continues to be strong with more than three quarters of AUM outperforming across all time periods. The percent of long term fund assets beating the Lipper category average improved slightly in the quarter largely attributable to improved performance at both Royce and Western.

Slide Eight shows our results from global distribution. Gross sales for the quarter were $15.4 billion and net positive flows for the quarter were $1.5 billion. Quarterly inflows were led by international primarily in Europe and in Japan. For the fiscal year we recorded record gross sales in distribution of just over $65 billion up 13% from the prior year with nearly breakeven net flows despite headwinds at Royce and in muni fixed income.

Retail sales for ClearBridge were up nearly 100% in the year and Brandywine and LMGAA also enjoyed strong sales momentum. I should note that approximately $2.5 billion in outflows for the year pertains specifically to Batterymarch and Esemplia. We’re very focused in distribution on expanding our shelf space with our intermediary partners particularly in absolute return products, alternative credit strategies and liquid alternatives. In the US, Western’s macro opportunities and Permal head strategies are now on a number of platforms gaining good traction and we expect to add Brandywine alternative credit to retail platforms over the next few quarters.

Now, let me talk about the steps that we’ve taken to position our distribution organization for the future. Our goal is to dramatically grow our US retail sales over the next few years. To that end, we continue to evolve our US sales coverage model this quarter. We are increasingly using client segmentation and geographic dispersion data to create what we believe is a differentiated distribution model. Using that data, we’ve segmented the business needs of nearly 200,000 advisors that we believe represent our opportunity set including advisors we work with today as well as those whom we have identified as having great potential for us.

We drew inspiration from the meaningful success we’ve had with our innovative cross channel team which we launched in 2011 and given that success our conviction is high that multiple coverage models can lift the productivity of all sales teams and create a more powerful distribution system. We intend to expand our global client facing resources and finally, to ensure that our sales teams think like business owners we introduced a new solutions oriented capital market space selling approach and a modified sales compensation plan to reinforce it.

With that, let me turn it over to Pete.

Peter H. Nachtwey

Turning to Slide Nine, I’ll start with the financial highlights. In the fourth quarter we had solid P&L results with earnings of $69 million or $0.58 per share. As expected, we had lower revenues reflecting a reduced level of performance fees compared to the prior quarter along with the impact of two fewer days in the quarter. We also benefitted from the continued share buyback, a higher level of AUM, and a continued relentless focus on controlling costs. This quarter’s results also reflected the impact of various business efficiency initiatives as well as integration costs related to the QS Investor’s acquisition which includes the combination of Batterymarch and LMGAA into one world class platform.

In addition, there were a number of year-end GAAP tax adjustments which negatively impacted the quarter. With regard to our efficiency initiatives and QS related integration costs, our actual expenses of $10 million came in slightly higher than expected for the quarter due to lease charges where we identified additional space that we can sublease. Looking forward to fiscal ’15, we are anticipating additional costs in the first half of the year of approximately $30 million related to the combination of Batterymarch, LMGAA with QS Investors.

Adjusted income was $104 million for the quarter or $0.86 per share which includes the impact of the severance and other initiative costs and the higher tax related items. Average AUM in total was up 3% from the prior quarter with average equity up 4% and average fixed income up 1%. Operating revenues were down 5% from the prior quarter due to the reasons I mentioned earlier.

This quarter’s total performance fees of $17 million were from Brandywine, Permal, and Western but were down from last quarter’s much higher level primarily due to annual calendar year end locks at Permal. While impossible to predict with any precision, we estimate the next quarter’s performance fees could be in the range of $10 million to $20 million subject to market movements. On the balance sheet front, this quarter we repurchased an additional two million shares for $90 million. Going forward, we continue to anticipate share repurchases of approximately $90 million per quarter, as always, subject to markets and/or growth opportunities.

Moving on to Slide 10, the only things to highlight here are a couple of tax related items including our effective GAAP income tax rate of 42% which was higher than normal due to a number of factors. These included the impacts of revised fiscal year end annual state apportionment adjustments as well as reserve and valuation allowance true ups. At the same time, we had tax related credits running through two other lines on our income statement. In the other expense line, there’s a reduction of $5 million for state franchise tax reserves and we had a $2 million reduction in interest expense due to a state tax audit resolution.

The net effect of all of these tax items was to reduce earnings per share by approximately $0.02. We are expecting our effective GAAP tax rate for fiscal 2015 to be approximately 36%. But most importantly, as you will see on a later slide, our actual cash taxes continue to run at a substantially lower level than our GAAP rate.

Turning to Slide 11, our assets under management were up 3% from the prior quarter mainly due to market increases of $14 billion which included favorable foreign currency movements of $2 billion. In the quarter, liquidity also contributed to the increase in AUM with inflows of $8.6 billion.

Long term flows on Slide 12, were slightly negative with equity flows improving while fixed income flows went in the other direction. Equity inflows were $500 million compared with $700 million in outflows in the prior quarter. This reflects continued positive momentum at ClearBridge, as Joe referenced earlier, and improving though still negative flows of both Batterymarch and Permal. Fixed income flows turned negative for the first time in three quarters driven primarily by the global sovereign mandate redemptions driving the outflows. Redemptions in that low fee mandate increased to $1.4 billion from $900 million last quarter.

On the liquidity front, inflows were almost $9 billion but as I noted last quarter, we anticipated and have seen in April liquidity redemptions of over $20 billion largely relating to a sovereign client’s seasonal cash needs. We would expect most of those assets to come back in over the next few quarters.

Slide 13 shows the advisory trend. With this quarter’s rate down slightly, primarily due to outflows at some of our high fee equity managers where markets did not offset the flow impact. These include Royce and higher fee product redemptions at Batterymarch. Average AUM increased 3% and within that move average liquidity assets were up 6% and average equity and fixed income assets were up 4% and 1% respectively.

Operating expenses on Slide 14 decreased to $562 million from $598 million in last quarter. I’ll discuss comp and benefits on the next slide, but in terms of the other specific components, occupancy expense increased due to about $5 million in real estate charges from efficiency initiatives that I mentioned earlier. Last quarter’s results also included $3 million of such charges. The amortization of intangible assets declined by over $3 million due to certain assets becoming fully amortized.

Finally, a variety of factors caused an additional net $6 million positive variance. These included the positive impacts of the $5 million franchise tax reduction along with last quarter’s results including a $5 million increase in the contingent payment liability for Fauchier which reflected their higher actual earnings level since the transaction. Partially offsetting these were higher professional fees related to the QS acquisition and various business initiatives.

Turning to Slide 15, compensation and benefits decreased overall by $25 million. The primary driver was lower revenue share related compensation due to the decrease in operating revenues. In addition, salary and incentives show a decrease in fiscal year end accruals for discretionary bonuses as well as higher non-compensation expenses at revenue share affiliates. Benefits and payroll tax increases were primarily due to a pickup in seasonal benefit cots in the March quarter. The combination of these factors resulted in a 53% compensation ratio which is a bit lower than our typical range of approximately 55% to 56%.

Slide 16 highlights the operating margin as adjusted which decreased to 23.3% from last quarter’s 24.1%. The lower margin was due to lower revenues reflecting the anticipated drop in performance fees and two fewer days in the quarter. Severance and other costs related to efficiency initiatives and business integration costs also had a negative effect. Partially offsetting these were the benefit from the franchise tax reduction. These combined to reduce the operating margins as adjusted by approximately 1%. Also, recall that last quarter’s margin included costs related to our efficiency initiatives which were more than offset by higher performance fees.

Looking ahead to next quarter, our margin will be influenced by approximately $15 million in integration costs related to QS Investors acquisition and as Joe mentioned earlier, we intend to invest in growth in fiscal 2015 and specifically, in our global retail distribution organization. We expect these costs initially to be in the $4 million a quarter range ramping up to $6 million per quarter in the second half of the year.

Slide 17 is a roll forward from fiscal Q3’s earnings per share of $0.67 to this quarter’s $0.58 per share. Fiscal Q3 had $0.11 of charges related to various corporate items including the previously discussed efficiency and the contingent consideration from the Fauchier transaction. Fiscal Q3 also had higher performance fees at Permal reflecting calendar year end locks and the impact off the decline to the current quarter’s performance fees of $17 million was also $0.11 per share.

The current quarter included the ongoing efficiency initiatives and QS Investors’ integration costs which together totaled $0.06 and as I highlighted earlier the impact of the various tax items including the higher effective tax rate but also the other expense and interest expense tax related reductions totaled $0.02. Finally, changes in net revenues and expenses partially offset by share repurchases for the third quarter, decreased earnings per share by $0.01.

On Slide 18 you can see that our effective tax rate for the quarter was approximately 40% while the forecast for the next fiscal year is for a roughly 36% effective tax rate. But the key once again, is our cash taxes which continue to run at 4%. We currently expect the cash tax rate to remain in the 4% range for fiscal 2015 and under 10% until we become a US federal tax payer again which we currently project to occur early in the next decade. This ultra low cash rate allows for both additional investments in the business and additional return of capital to shareholders.

As a reminder, our cash tax rate benefits from our NOL carry forwards and our ability to amortize goodwill and indefinite [inaudible] intangibles for tax purposes but they are not amortized for GAAP. When you translate our cash tax rate into estimated dollars saved, which are on the right side of the schedule, you see that over time we anticipate realizing a total cash savings of $1.3 billion.

I’ll wrap up on Slide 19 which highlights a number of balance sheet items including both our return of capital to shareholders as well as how our capital structure has changed thanks to the highly successful 30 year debt offering we announced earlier in the quarter. In the upper left you can see that we have reduced our share count by 46 million shares or 28% over the last four years and we still have $370 million of repurchase authorization remaining. In the upper right we’ve highlighted the change in our quarterly dividend over that same time frame. As we announced this past Tuesday, the board of directors approved a 23% increase in our dividend to an annualized $0.64 per share starting in our fiscal second quarter which is our fifth straight year of an annual dividend increase and a 500% increase in the dividend over that timeframe.

On the bottom of the Slide you can see our new debt structure which now includes the $400 million in 30 year debt with a 5.58% coupon and we now have no fixed debt maturities until 2020. Finally, on the capital front with the increased size of our undrawn bank revolving credit facility of $750 million and with the excess cash in our balance sheet we have substantial dry powder to invest in the business.

In summary, we’ve returned capital to the shareholders both through the dividends and share repurchases and we have significantly improved the liability side of our balance sheet over the past few years with two debt transactions that allowed us to extend maturities in both instances and delever by a combined $450 million.

So, thanks for your time and for your interest in Legg Mason and now I’ll turn it back to Joe.

Joseph A. Sullivan

Slide 20 shows the performance of our stock price against all of the actions that we have undertaken in the last 12 months as we have continued to build a better Legg Mason. We’re certainly pleased with our stock performance over the past year which we believe represents significant progress on key fronts, an improvement of $28 billion in long term flows, a 5% increase in revenues, and meaningful improvement in our adjusted operating margin. At the same time, we understand that we have more work to do. We must continue to leverage the many assets of our organization and focus them behind our primary goal of delivering sustainable long term earnings growth.

This Slide highlights that it is the accumulative effect of many smaller actions that has driven success on a number of fronts. We added new board members with a broad base of expertise across the asset management industry. We’ve strengthened our management team with the hiring of Tom Hoops to head our key business and product development efforts. We’ve implemented two management equity plans and are in discussions with other affiliates to expand those agreements.

As we’ve said, we believe strongly that these MEPs are a critical component of building investment franchise value over the long term. We’ve addressed small non-core or underperforming affiliates in a variety of strategic ways. We’ve acquired additional investment capabilities and created greater scale across our affiliate’s portfolio by combining complementary investment platforms in ClearBridge Investments and Legg Mason Capital Management as well as QS Investors with Batterymarch and LMGAA. We are very focused on filing remaining product gaps and are determined to further leverage our global distribution platform. Finally, I am confident our balance sheet and cash generation will continue to be a significant benefit to our shareholders.

Slide 21 shows the four key areas against which we will continue to execute with a single minded focus on excellent: product; performance; productivity; and distribution. In the year ahead, we remain committed to building our non-US equity capabilities and we will look to continue to opportunistically add alternative capabilities in such areas as real estate, private equity, or energy. Each potential acquisition that we do must be a strong cultural fit with Legg Mason and our expectation is to have, over time, larger affiliates with none expertise and stronger brands for our distribution teams to even more effectively market and we’ll never lose sight of our commitment to running our business in the most efficient and effective manner possible.

All-in-all we made very good progress in fiscal 2014 and we look forward to building on that momentum in fiscal 2015. With that, we’ll now take your questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Christopher Harris – Wells Fargo Securities.

Christopher Harris – Wells Fargo Securities

Joe, just a question for you regarding the growth of the retail channel that you kind of talked about. The data and the client segmentation initiative, just wondering if you could maybe expand on that concept a little bit more, maybe help us out with the kinds of data you guys might be looking at or how exactly you’re looking to segment the channel that could potentially help spur growth. Then related to that, are there other examples in the asset management industry of a company kind of approaching the retail channel in this way or do you guys think you might really be the pioneers in this area?

Joseph A. Sullivan

A couple of thoughts, first of all, I think that we’ve been successful in helping people see that our global distribution platform is really a clear strategic asset for the company and one that continues to deliver results. Our belief and our view is that we can do better and we can do more. What is interesting, and I wonder if you and others have seen all of the headlines have been staggered with the number of headlines recently with other firms scrambling to build what we already have.

But, what we’re focused on here is taking what is a strong distribution platform to the next level. Frankly, to a much higher level. It’s going to focus on two themes, the first being the increase in the effectiveness of our current sales force. We’re going to do that utilizing technology, enhancing and building out our marketing and on our global training programs. Then secondly, we intend to expand and deepen client coverage where we believe that we have significant incremental opportunity.

We do expect that we’re going to add additional client facing staff, sales people and client service types primarily in the US. We could see an uplift there by as much as 20% or so. We will also add tactically internationally on the staffing side. As it relates to sort of utilizing big data, we can increasingly segment, and we’re not alone in this, but we can increasingly segment what advisors do, their investment styles, what types of products they’re focused on at a very granular level and what that allows us to do is be much more effective in targeting when we go into see an advisor. We’re not having to tease out what kind of business they’re doing, we know, we can see by virtue of the data what kind of business they’re doing so our meetings and our interactions with them can be much more focused and frankly, much more effective.

We’ve, as you have seen and as others have seen, we’ve been growing our annual business, our retail distribution business without making any investments. What we’re excited about is with making a modest investment we’re excited to see how much further we can take it.


Your next question is from Macrae Sykes – Gabelli & Company.

Macrae Sykes – Gabelli & Company

Could you speak about the importance of QS now in the integration within your retail distribution growth goals?

Joseph A. Sullivan

Some of you have heard me use the term strong transaction big deal and that’s really the way we think about the acquisition. QS was very exciting to us on its own and then when we began to evaluate it in combination with Batterymarch and LMGAA which was already our manager of managers solutions approach, it became even more compelling to us. I can’t even begin to tell you the level – I think if Janet Campagna was here she would tell you they’ve been a little bit blown away by the amount of interest and attention from our product teams and our distribution teams in terms of what we can now create and compete for on the sub advise side as well as on the retail side.

We’re really excited about the retail products we can create. We can now talk about a much expanded set of products in the sub advisory world. So it’s taking the best of these three platforms and really building a new QS. We do think Mac, that this whole move towards solutions and outcome investing or whatever you want to call it, whatever the buzz word is. We do believe that that’s not just a current growing aspect or approach to the business but we think it’s enduring. We don’t think it goes back. It is a highly customized approach both institutionally and on the retail side and so our ability to sit down whether it be with institutional clients now, sub advisory type clients, retail intermediary clients, and customize and create the exact type of investment they want with an outcome that they’re seeking.

We just think this is an enduring and permanent approach to the market. QS is world class in that respect as well as the legacy folks from Batterymarch and LMGAA. We feel like we’ve got a winner here.


Your next question comes from Daniel Fannon – Jefferies & Company.

Daniel Fannon – Jefferies & Company

I guess just a question on fee rates and kind of the outlook and I guess we can do the math and look at the growth and liquidity assets for this quarter and see potentially why the fee rate went down. But thinking about the outflow Pete that you mentioned in April, should when we think about the fee in liquidity should we assume all else equal that that fee rate will start to expand going into next quarter?

Peter H. Nachtwey

Keep in mind it’s a pretty tiny move, because it’s basically the fifth digit to the right of the decimal point here so we’re slicing the salami a little bit thing. On the other hand, we would have been expecting it to go up but between Royce and Batterymarch, both relatively high fee products that were in outflows but that didn’t get offset by markets last quarter, that’s really what the impact was. But keep in mind, as you pointed out, liquidity as well ticked up a bit and given the massive amount that has gone out this past month we would expect that to start having the yield going back up again.

But keep in mind, as we said at our investor event there is really three mix factors that matter for us and this is just one of them so equity versus fixed is certainly a key element but the other two are also important. One is clients, retail versus institutional and then the other is the mix of affiliates. So, you kind of look at our operating margin netting out the big spike we had last quarter in performance fees and we still continue to maintain a solid operating margin so the other two mix items more than offset this tiny move in the yield. But, your premise is correct, we would expect it to start going back up this quarter.

Daniel Fannon – Jefferies & Company

If I could follow up on just some of those expense line items, there was some moving parts specifically, like occupancy, is that now tracking, if I normalize that, in the mid 20s based on the last couple of quarters of one time stuff? Then if you could also just give us some geographic expenses for the charges going into next year with regards to the integration?

Peter H. Nachtwey

I would say the run rate occupancy is probably closer to 30 but this past quarter has $2.5 million as I mentioned, in one time charges. We identified a little bit of incremental space and we’ll get some marginal so there’s a bit of a onetime charge in there for that $2.5 million and probably less than a million on an annual basis of run rate savings on that. Then the geography on some of the other onetime items, a lot of that was running through other expense so we had, if you look at last quarter, we had a $5 million payment to Fauchier just due to the fact that it outperformed where we expected when we bought them originally so we had a contingent payment that we were pleased to make but that actually ran through other expense.

We did not have that again this quarter and then this quarter we had the $5 million in franchise tax. Franchise taxes are a little bit neither fish nor fowl but they end up in the other expense line and there we resolved some issues. We had some reserves against various states that have franchise taxes that benefitted us by $5 million. In that same line again, other expense line that’s above the operating income line, we had some professional fees related to QS and again, some of the initiative costs. I think that captures most of everything.

Daniel Fannon – Jefferies & Company

We should see it in comp and other as well?

Peter H. Nachtwey

Your second part of your question, yes on the investments going forward I’d say the majority of it is going to be in comp. It’s going to be mostly in comp and then a bit in technology and communications.


Your next question comes from Michael Kim – Sandler O’Neill.

Michael Kim – Sandler O’Neill

First question, just as you continue to build out your global distribution platform and gain momentum there, do you get the sense that can be somewhat of a selling point in terms of your discussion with potential new affiliates that might look at that and think about possibly leveraging that platform to step up there growth?

Joseph A. Sullivan

I can tell you there’s no question. I think, as I mentioned earlier, we’ve come to help people realize the strategic asset that it is. We’ve continued to grow it over the last several years. We run it highly efficiently, but it has even greater potential and when I’m out talking and I’m out meeting with potential acquisition candidates all the time, there’s a number of reasons why we’re an attractive acquirer but none is more important than the access to distribution and what’s happening in the industry, and I think what a number of other firms would tell you is that the larger global banks and intermediaries are overwhelmed with the number of managers that want to gain access to their platform.

What we bring that those smaller managers don’t, is multi hundred people in the field being able to actually support it. So, if you’re a large national broker dealer or independent firm and somebody has a great product but they don’t have the field sales force to be in and support it, firms don’t like to just put products or strategies on their platform and not get flows to it. So, we’re able to go out and when we get something on a platform, support it in the field both in the US and globally to help drive sales and so it’s absolutely a huge strategic advantage and maybe it’s our opening calling card when we’re talking to potential acquisition candidates.

Michael Kim – Sandler O’Neill

Then my follow up, it seems like one of the key themes maybe emerging across the institutional equities landscape is just sort of a pickup in demand for more concentrated equities strategies so I’m just wondering if you’re starting to see signs of that and how that might play out for affiliates like ClearBridge or even Royce in terms of that dynamic?

Joseph A. Sullivan

I can’t speak candidly to whether we’ve seen a specific increase in inquiry around what you described. What I can say is that you highlighted both Royce and certainly at ClearBridge, we’ve got high conviction strategies that are performing well right now, concentrated strategies. Richie Freeman’s product at ClearBridge has got a terrific track record and is a high conviction more concentrated strategy. Royce, kind of the same thing in various strategies. I can’t necessarily confirm that we’ve seen a lot of institutional interest specifically in high conviction but we do have strategies in that space that I think, are pretty compelling.


Your next question comes from Craig Siegenthaler – Credit Suisse.

Craig Siegenthaler – Credit Suisse

Can you provide us a quick update on how much AUM is remaining from the outflow in global sovereign mandate and should we expect sort of the $1.4 billion run rate of the current quarter to continue over the near term here?

Joseph A. Sullivan

I think what I said in my comments is that we were going to modify our disclosure around the assets that we have to begin, and this is really driven by the acquisition of QS Investors and the significant book of assets under administration that they bring with them which is approaching $100 billion. So as a result of that, what we’ve decided to do is put that as a category into itself. We will move the global sovereign mandate into AUA now because it’s more consistent with assets under administration.

If we were doing that today I think we would have something north of or in the area of $120 billion if you include QS plus what we already have. We have something, among three or four affiliates, we have something on the order of $20 billion or so in other AUA. Now, that AUA we have in other affiliates, only about $12 or so of that would be currently in our AUM. The other $7 to $8 of it is not in our AUM but, it more accurately describes the business that we’re doing. I hope that answer your questions.

Look, is it still going to be in outflow? Yes, I expect that it ill. We were surprised that it ticked up this year candidly, but there’s a lot that goes on with that. But we would expect it would be still in outflow, but as it continues to outflow, our expectation is that it will stabilize at some level.

Craig Siegenthaler – Credit Suisse

With the QS transaction closing at the end of May can you talk about how you expect net flows to trend from the current Batterymarch and also the LMGAA asset base as you integrate these three businesses together, there might be some kind of lump outflows ticking up there?

Joseph A. Sullivan

Let me just embellish on that a little bit because you’re right, any time you do a transaction that’s sort of a catalyst for any client that was perhaps thinking about making a change to do something. So, when we did the QS acquisition and in particular when we look to combine it with GAA and Batterymarch, we did a lot of work around modeling what we thought we could lose from GAA or Batterymarch as a result of this conversation. The candor around that is we knew we had some strategies, particularly at Batterymarch that were a bit challenged and we knew we would be vulnerable there.

We have seen some lumpy outflow in April from that but, what I will tell you is our total, and we don’t have it it’s not final yet and I can’t confirm it until we kind of close and we see where the clients shake out but, I’ve personally been involved with our teams, our teams have done a great job in outreach to their clients and teams at GAA and their teams at Batterymarch in tandem with the teams as QS. All of those conversations are going very well and we are meaningful I would say, exceeding what we modeled in terms of our expectations for outflows.

I mentioned we had a bit of a bump and again, this was expected in April so I would say April just to share with you, we saw about $400 million or $500 million from Batterymarch come out in this month which we expected, not a surprise. We also candidly had an outflow, I think I mentioned, from ClearBridge. That was a reallocation, a sub advisory reallocation of about the same amount $500 million or so and so we had about $1 billion in outflow. But net-net we think, although we haven’t gotten the final numbers of course, but we think April will come in kind of flattish in terms of flows even with those two larger outflows. But to your point, retention of assets at QS, Batterymarch, and GAA is going much better than we expected.


Your next question comes from [Unidentified Analyst] – Citi.

[Unidentified Analyst] – Citi

Just to follow up on Dan’s question, you noted that the investments will be in comp and tech related to distribution, can you quantify that at all?

Peter H. Nachtwey

In terms of tech and comp, roughly in the early quarters we’re probably going to have more of it in the technology line. It could be as much as 50% to 75% and then the remainder in comp and as we get into the back half of the year it will be about 50/50.

[Unidentified Analyst] – Citi

Then just to the pipeline, the fee rate obviously ticked down, but what should we expect from the pipeline as far as the composition of the fee? Is it higher or lower than the company fee rate currently?

Peter H. Nachtwey

In that pipeline as Joe said, about $2.5 million relates to Western though we’ve got similar amounts at Brandywine and about half of that at ClearBridge so based on that mix in terms of the unfunded wins we’d be expecting those to help our advisory fee rate.

Joseph A. Sullivan

I think one of the other things, just for a little color Pete, would be Permal’s unfunded wins are up nicely at about $800. In addition, both at Western and at Brandywine, just so you understand, we are continuing to see this move towards unconstrained absolute return. Western’s macro ops strategy is continuing to gain traction and flows. So in what are typically at least a little bit higher fee mandates within the fixed income space, that’s where we see the business currently moving both institutionally and retail in these unconstrained, these alternative credit strategies, whatever you want to call it, that’s where we’re seeing increasingly the flows going in fixed income.

Peter H. Nachtwey

Just to be balanced, we know we’re still going to have a little bit of headwinds with Royce and their higher fee type of products. But again, as I mentioned earlier when Dan asked the question, keep in mind the mix between retail and institutional which continues to improve and then the mix of the affiliates of where the earnings are coming from.


Your final question comes from Mike Carrier – Bank of America Merrill Lynch.

Mike Carrier – Bank of America Merrill Lynch

I think you gave a decent amount of color but it just seems like on the expense side there’s a lot of moving pieces and I think on the occupancy you mentioned that sort of $30 million kind of being a decent level in terms of normalization and then I think on the other, because of the things last quarter and this quarter, maybe something around a $50 million would be somewhat normal. So I guess when we think about the investment in distribution that four going to six I’m assuming that would be mostly on the comp side? I guess the ClearBridge incentive or equity plan is nominal so it’s not really going to have an impact [inaudible] comp and then the charges with QS, just where those would fall. But, I just wanted to make sure there was nothing else in the quarter because it just seems like there is maybe more than usual in terms of moving pieces.

Peter H. Nachtwey

I think we try to make it simple with the [walk] Mike and again, I think there’s a bit of noise in the quarter, but if you look at the EPS roll forward, it summarizes things pretty nicely so we’re not envisioning this $4 million spend per quarter. As we talked about all last year we’ve been focusing on efficiency initiatives to help us pay for that and so the combination of that plus higher AUM, a full year of the higher AUM levels, should keep us kind of growing nicely in terms of operating margin, bottom line, in spite of making some modest investments here in terms of distribution.


Thank you. That concludes our question and answer session. I would now like to turn the floor back over to Mr. Sullivan for closing remarks.

Joseph A. Sullivan

As we close the call this morning first I’d just like to thank you all again for your interest in Legg Mason, but I’d like to take a moment and thank some very important people. First is, we announced yesterday John Cahill has announced that he will not stand for reelection to our board of directors this July as he focuses on some very important new responsibilities that he has assumed. I’m very grateful for John’s service to our board and in particular his leadership and counsel to me over this past year.

Harold Adams has reached the mandatory age of retirement from the board and John [Kerner] has decided to retire from the board and not stand for reelection. Both of these gentlemen have served Legg Mason shareholders as board members for over 20 years and have been stewards off the culture and commitment to clients that reflects the Legg Mason culture. I can’t express my gratitude enough to both men. At the same time we are very excited to welcome John Davidson to our board. I am very anxious to work with John and draw from his considerable experience in the years ahead.

Secondly, I just want to thank and commend our colleagues from Batterymarch and LMGAA for their incredible hard work and dedication to our clients as we navigate the combination of those two firms with QS. It is clear that these dedicated colleagues continue to put clients first and have worked tirelessly to make this combination as successful and seamless as possible. Thanks team.

Finally, to all of my colleagues in our affiliates and at Legg Mason, thank you for all that you’ve done this past year to move the company forward and for your commitment to building a better Legg Mason. We still have a lot of work to do but we have made substantial progress and I am incredibly proud of all you have done on behalf of our clients and shareholders. With that, I wish you all a great day and I look forward to our next call.


Thank you. Ladies and gentlemen this concludes today’s conference. Thank you for participating. You may now disconnect.

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