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Legg Mason, Inc. (NYSE:LM)

F2Q08 Earnings Call

October 24, 2007 8:30 am ET

Executives

Tim Munoz – SVP, Head of Corporate Marketing and Communications

Chip Mason – Chairman, CEO

Barry Bilson - SVP of Finance

Analysts

Tom Gallagher - Credit Suisse

William Katz - Buckingham Research

Robert Lee - KBW

Cynthia Mayer - Merrill Lynch

Prashant Bhatia – Citigroup

Michael Hecht - Banc of America Securities

Douglas Sipkin - Wachovia

Operator

Welcome to the Legg Mason quarterly conference call. (Operator Instructions) I would now like to introduce your host for today's presentation, Mr. Tim Munoz. Mr. Munoz, you may begin, sir.

Tim Munoz

Thank you and good morning. On behalf of Legg Mason I would like to welcome you all to our conference call to discuss operating results for the fiscal 2008 second quarter ended September 30, 2007.

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 Condition and Results of Operations” in the company's annual report on Form 10-K for the fiscal year ended March 31, 2007; and also, “Management’s Discussion and Analysis of Financial Conditions and Results of Operations” in the company's quarterly reports on Form 10-Q.

This morning's call will include remarks from the following speakers: Legg Mason’s Chairman and CEO, Mr. Raymond A. “Chip” Mason; Mr. Barry Bilson, SVP of Finance, who will discuss Legg Mason's financial results.

In addition, following a review of the company's quarter, we will then open the call to a Q&A session.

Now I would like to turn the call over to Mr. Chip Mason.

Chip Mason

Good morning, everybody. Excusing the gain that we made in December of '05, this was the second-best quarter we've ever had. We have had disappointing, continued equity outflows, which you and we are both very aware of and we are spending a lot of time on. You should not be surprised with the continued performance issues. Obviously, most of these are visible to you in daily numbers.

However, we remain confident in our managers. We believe that our business model is as good as you can get and we believe that we have some of the finest managers in the country, and in some instances, in the world. Managers do have good and bad periods.

The markets for the quarter in general, as you know, were shaky. The global credit issues were large and constant. The Fed cut the discount rate and the Fed funds rate and they have projected -- or it appears to be -- that there will be more to come. The spreads have tightened in most sectors. An example would be a three-year home equity. The current spreads are 100; the ten-year average is 30, and that would be down from a high of 150 in August. So obviously, they continue to be well above historic averages, although better and improving.

The ABCP (asset-backed commercial paper) market has improved. It seems to improve a little bit every day. The volatility in the equity markets remains. The DOW has fluctuated plus or minus 1% for 23 out of the 63 days in the quarter; somewhat of a roller coaster. The DOW started the quarter at 13,500 and then went down to 12,900 mid-August and then closed the end of September at 13,900. So therefore, the indices closed at near record levels. Major financial firms mark-to-market hundreds of billions in securities and we saw $90 per barrel for oil. A lot of this no one would have predicted as little as six months ago.

Our net income for the quarter was $177.5 million. As I indicated -- well as you know -- last quarter not including the gain was our best quarter ever; this quarter being our second-best quarter than ever is off 7% in net income from the prior quarter but up 24% from a year ago. On a diluted EPS, we are also off 7% from last quarter at $1.23, but up 23% from last year.

Our cash earnings per share, which I keep hoping will you listen to, is an important financial metric, in our opinion, to consider particularly in our case when it is 30% higher than our GAAP earnings per share. We have considerable intangible write offs for book and tax and it gives you a clearer picture what our cash generation actually is.

We have continuing operating cash earnings per share of $1.60. Last quarter was a record. We were off 3% from last quarter, but up 20% from a year ago in those cash earnings per share. In actual cash earnings, we had $231.8 million, also off 3% from our record last quarter, but up 21% from the prior year.

Our assets under management went over $1 trillion, which in and of itself is quite a benchmark. We may not have gotten there -- in common day vernacular – pretty, and maybe not the way you would have liked for us to robustly have gone through it, but we did go over $1 trillion; certainly a monumental task from our standpoint and one of which we are very proud.

We increased in the quarter $19.2 billion, up 2% from last quarter which was $992.4 billion. $18.9 billion came from market appreciation and $300 million from close. We had solid flows for our long-term fixed income assets, up about $11 billion. Our liquidity flows were basically flat, maybe off a billion. Our equity flows were off $9.6 billion, which is the number that you all tend to focus on.

I have to say, involved in that you should not really look at that $9.6 billion as hopefully a real number because we had the loss of a 529 plan which had been announced and that we were well aware of, for political and other reasons. Then we had a realignment of a major fund that was basically going to a much broader platform and we had a lot of those assets and therefore when they went to an open platform, we lost $2 billion in equity and $1 billion in debt coming off of that platform. So the number, which still is large, would have been more like $6.6 billion if that had not taken place. But still large, still concerning. The lack of equity flows to some managers continues to be an area obviously of our focus.

There are some signs of improvement and the market’s increased bias to growth should help us, because as you know, we now have a lot of growth-oriented managers. One of the things that we mentioned that I'll just reiterate for a minute, we do track this, we do look at it pretty hard, but the percent of our assets in our mutual funds that are beating the averages has now moved from 39% in June of '06 which is when we completed the realignment of the mutual funds, it has moved from 39% to 55% today. We think that's an important metric. We are not beating the band on it because we need more time to be convinced that this trend is now truly moving in the right way. But we are certainly encouraged by such numbers.

There were periods when we led all these categories and we were originally going to talk about this, but we went back and looked at the at ten-year numbers and the ten-year numbers we were at 89%, which tells you how strong we have been for quite sometime in beating the average. Western had beat 100% of them, Legg Mason funds had beat 94% and Citi, now the Legg Mason Partner Funds, had beaten 86%. We love the return to the glory days.

Even our five-year numbers remain strong, even with these earlier numbers and they were in the 76% range. So we are hopeful, but it's too short a time to be convinced that this is doing what we are trying to do.

We do believe performance is the key to our generating flows. I can't speed that process on. You can beat on me all you want; I don't run the money. I'm very hopeful that this is a good sign. We do not interfere with the investment process. We feel that you if have good managers, you are going to let them run the money and they make the changes as they see fit.

As an example of that, Capital Management made a decision, came out in August and announced a shift to mega caps which will tone down their risk volatility. There are several products and managers that continue to perform well and all had strong performance and flows. They continue to build their U.S. institutional separate account business with a new, substantial mandate.

Noteworthy in the equity mutual funds, Legg Mason Partners Capital Income Fund with about $3.5 billion in assets has been moved to four star. It's in the 9 percentile over the 12 percentile for three years and the first percentile for five years. We believe this is an example of a success story of reorganization.

The Legg Mason Growth Trust, which is $1.3 billion, a four-star fund run by Robert Hagstrom, who was put up for one of those, supposedly to be considered for Manager of the Year. It is in the second percentile for one year, the 31st percentile for three years and the first percentile ranking for five and ten years. Both the prior fund, Legg Mason Partners, which is a Gendelman Fund and the Hagstrom fund are examples, we hope, of things to come.

Fixed income had a difficult quarter but rebounded well. Western Core and Core Plus Institutional Funds, weak returns most of the quarter. They were ranked in the bottom deciles for July. They rebounded nicely in September and were running in the top centile for the month of September. Legg Mason Partners Managed Muni Funds, $3.1 billion, our larger muni fund managed by Joe Deane and David Fare, versus a Lipper category, were in the second percentile for one year, fifth percentile for three years and 19th percentile for five years.

In the UK, long-term fixed income has now shown marked improvement over the past quarters.

International, the appetite for investments internationally remains high. However, non-U.S. investors sold a record amount of U.S. assets during the month of August. Our assets under management clients domiciled outside of the U.S. continued to grow and be a focus.

Other news that I will comment on; the board, as you know, had authorized up to 5 million shares in the July board meeting could be repurchased over a period of time. In the quarter we repurchased 1.1 million shares. Our goal remains to create shareholder value and additionally to continue to service our debt at $50 million per quarter. First priority for cash remains probably in the international equity area as we've indicated before.

Just to mention the CEO search, a four-person committee of the board has been established for probably some four or five months now. They are actively engaged. They are utilizing the assistance of an executive search firm. At this point, there has been no deadline announced, but they are moving.

In closing, we focused on growing the business and we have in the distribution side, which is important to us in an area that we've spent a lot of effort in the last six to nine months. We have established some new and exciting relationships with distributors, new product development to meet the changing needs of investors. For example, the aging population and the first baby boomers to get Social Security benefits.

We are confident that certain of our equity managers will return to their longstanding level of strong performance, and that would benefit our bottom line substantially. We are certain that we have the strategy and tools to be and remain a premier global asset manager.

Barry, I will turn it over to you.

Barry Bilson

Thanks, Chip. Folks, I'm going to move fairly briskly in light of the fact that I believe when you look at the quarter there are very few things in here that are going to distract or confuse.

Just to eliminate a question, just to clarify one point, in the release there is the reference that this 529 plan loss in the retirement plan restructuring cost us about $2 billion in equity AUM. The total loss from those two events was about $3 billion. The difference between the $2 billion and the $3 billion of $1 billion actually was in the fixed income space which would be in both the long-term fixed income bucket as well as the managed account area.

Going to the numbers, again, I don't think there are many things that are going to confuse or surprise. In many respects, this quarter is very similar to last quarter. If you reflect back to my comment last quarter was last quarter was “about as normal a quarter as you would see, without a lot of distraction or noise.”

The realization rate on the average AUM is identical sequentially at about 38 spot mined basis points on an annualized basis versus 38.2 for this quarter of last year.

The net distribution expense; again, the encouragement is the best correlation you have to drive off there is to look at the distribution expense versus the sum of the funds advisory fee revenue, plus the distribution and service fee revenue. Again, we've been through this random discussion a ton of times. But there are pieces obviously in the fee side that is the payment stream for the expense.

If you look at that, again, sequentially it's virtually identical plus or minus a couple of decimal places, 41.8% versus 42.3%. Again, that should not surprise. Dealing with just a couple of items that I think you are going to be looking for some clarity on, in the revenue stream actually performance fees are down substantially on a sequential basis, basically identical to last year. You'll recall that last quarter there was reference to an annual fee that was in that line. Obviously we hope to have it again, but we'll have to wait until the June quarter of next year. That was like $6 million or $7 million.

There are eight subsidiaries that have products with some level of performance fee. Virtually all were lower this quarter than last. But last quarter was the strongest performance fee quarter we've had probably since the deals closed, with the exception of the December '06 quarter, which again is historically and to be anticipated going to be a quarter with a probable spike, really related to Permal where there are a number of products that had annual calendar year measurement periods, so we will report all income for the full calendar year in that December quarter.

Just to save you from going back to your notes, last year that number was about $23 million of calendar year measurement period Permal performance fees. This year we are optimistic, but obviously there is some quarter left to go that that number would certainly be somewhere in that neighborhood or better for the ’07 calendar year.

It's tough to pay a norm for this thing, but if you insist on trying to do something, tweak it depending on what the market environments are. But if you are dealing with a $35 million level, plus or minus $5 million, that's about as “normal” a benchmark as you can have.

It is very unlikely you are going to see this thing ever end up tripling up, quadrupling up; it's not the metric that we are dealing with but the products that we have performance fees driving off of. You are not looking at the 20% of performance gain as a starting point in what we are dealing with. So it does have some volatility and variability but not to a tremendous magnitude.

Enough on that one. The other operating revenue last quarter, you may recall was a little bit higher with some extra commissions and account fees, the indication at that point was $4 million to $5 million is about a normalized level. That's where we are sitting for the quarter.

Comp and the benefits relative to net revenue, basically identical across the board, about 50%; 50.5% this quarter, 50.4% last quarter, 50.0% the year before, which again, is the concept of the model to try and maintain margins regardless of what has happened with the revenue.

The non-comp, non-distribution expenses sustained quite well, actually backed off about $2.5 million sequentially at $142.6 million. Again, certainly an indication that we are over a lot of the transition hump. There was obviously some discretionary spend, marketing/advertising that eased some this quarter but you should not be anticipating a dramatic escalation in those expenses absent something new that we would probably try and indicate to you.

What else do I need to point out? The tax rate is identical sequentially. The other thing I'm sure will be a follow on, so let me address it now. Two things: on the cash EPS, you will notice that sequentially there was a meaningful jump in the add-back on the intangible-related taxes. That's really a cyclical situation with some imputed interest on an escrow on one of the earn outs. It should back off about $7 million next quarter, which would trim about $0.04 per share on the cash earnings per share. You may see it again this cycle next year. I know that's going to stand out a little bit to you.

The other thing we anticipate a question on is the diluted shares outstanding with the stock repurchase. I reinforced that we had a meaningful stock repurchase this quarter of 1.1 million shares. That had a marked bias later in the quarter. The impact in this quarter, 300,000 to 340,000 shares, so you'll have an additional 650,000 to 660,000 of impact into that diluted shares outstanding count next quarter.

I know that was quick and I'd be happy to answer any specific questions you may have. The other thing I should touch is the non-operating revenue. Again, last quarter really was the anomaly. It's down $6.5 million sequentially. You recall there was about a $3.5 million gain on the disposition of a joint venture and obviously there is a lesser amount of mark-to-market on some investments, predominantly the funding mechanism on some of the deferred compensation plans.

I know that was brisk, but I'm not going to belabor things that I think are probably in line with your view and expectations.

With that in mind why don't I ask Howard to open it up for questions?

Question-and-Answer Session

Operator

Your first question comes from Tom Gallagher - Credit Suisse.

Tom Gallagher - Credit Suisse

The first question I have is a follow up on the fixed income side. Can you talk a little bit about what's going on there? Chip, I know you talked about there was some deterioration in performance for a couple months, but you've come back. The long-term numbers are still real good.

Can you talk about the visibility or the expectations there? And maybe give a little perspective on how you think clients are looking at the current market? I say that meaning my expectation would be you wouldn't necessarily see any kind of meaningful pick up in redemptions based on a few months of under performance, but I'm a little surprised that the net flows were so strong in that area, just because of the recent performance issues. Can you give a little color on that? Thanks.

Chip Mason

I'll do the best I can. First of all, in 2002 we had a hiccup in the summer that was different in effect that it wasn't nearly as publicized and widespread as this market has been, but it certainly was a pretty severe setback. As you probably know, and many people do know, that Western tends to be much more on the credit side than other managers. That's really why most periods they've outperformed everybody -- not all, but most. It is because they tend to be a little farther out on the credit scale than others are and therefore, anytime you have a dramatic or rapid change in credit markets they tend to get hit by it.

I think their clients are well aware of that and I think their clients, at least on the institutional side, more or less expect that in effect that Western has always been the one that has sort of been heavier in corporate and been out there on the credit side.

The reason I cited 2002 was they were just getting killed that summer and obviously what happened is the spreads widened, they were suffering and feeling the pain, obviously as were their clients. By the end of December they had recaptured it all and if I remember correctly, came out with the best numbers for the year, which I don't anticipate happening quite that rapidly this time.

But, when markets tend to turn and then turn back and spreads pull in, which is the biggest issue here, they tend to get hit the hardest going in and then come back the fastest as spreads continue to pull back to more norm; whatever norm is in somebody's mind. So

I mean, they are still winning mandates obviously in the long-term business, which has always been there, where they are best known. That hasn't seemed to have slowed down. The differential is small, if any. But obviously, these kinds of markets affect you and affect your thinking and we are hopeful that we will have another rebound that puts us back the way it was in 2002, meaning as fast as it did.

I hope that answers it.

Tom Gallagher - Credit Suisse

It does. So bottom line is despite the fact that the long credit trade hasn't worked out in the short term, you still think most of their clients, the credit story is still resonating with most of their clients on the sales side. Is that fair to say?

Chip Mason

From everything we can tell that is true, Western has done their usual good job of getting in front of their clients, reminding them how they run money and what they've done, wishing obviously that they had seen it coming or didn't have the bump. But it is part of what they do and their long-term record obviously is still sensational; their short term record is not as sensational.

Having that to be the case it appears that all of their long-term portfolios remain intact. Actually, one of the areas that has been a concern with us is we always had very good European numbers and the last 18 months to two years those numbers have gotten weaker which had not been our prior experience. That's a big market, because that is probably close to $100 billion, if not $100 billion out of London. Those numbers have turned back up. That probably is something that will help us more than we realized, because our concerns were that it had gone too long and that appears to be better.

Barry Bilson

Just for a point of reference, Tom, this is probably the third or fourth time over the past 20 years that there has been this kind of dynamic that has hit Western relative to their approach and their bench strength. In those prior occasions, they remained positive in flow in each and every occasion.

Tom Gallagher - Credit Suisse

That's helpful. Just one follow up, can you comment on the change in the distribution relationship with Citi? I realize that does potentially open up new distribution outlets for you, but can you also talk about the potential downside risk of what might happen to retention and sales through the Citi distribution?

Chip Mason

You're talking about the agreement with the Value Trust, I'm assuming that's what you mean?

Tom Gallagher - Credit Suisse

Yes, it is.

Chip Mason

I think that Smith Barney would view this as, they were very anxious to make sure they had some form of an exclusive arrangement with the Value Trust. they got that. The parameters of that were widened dramatically which does give us a broader ability to distribute the product on a much wider base. So from the standpoint of Bill and his team, that was an important thing. My guess is either both parties thought they won or both parties thought they lost. But they came out with something that they were relatively happy with on both sides.

The retention issue is a Smith Barney issue, not ours. I'm going down the path I think you're asking me as a question. The retention issues only -- probably as far as the agreement is concerned -- the former Legg Mason brokers that own a lot of the Legg Mason Fund, I think Smith Barney viewed this as an important retention vehicle to keep them with Smith Barney. Not that I think they are going to leave, but I think they viewed it that way. They have had some retention issues over the past couple of years and so they, Smith Barney, are more sensitive to that subject than probably others. But I don't think this is really a big factor in that issue.

It does open up new areas for us to sell the funds, though.

Operator

Your next question comes from William Katz - Buckingham Research.

William Katz - Buckingham Research

Good morning, everybody. You guys are going very quick and I joined a little late and I apologize for that. A clarifying question for you; can you just review if you gave any comments on why the distribution margin compressed sequentially?

Barry, I wasn't following your guidance on performance fees. Was the $35 million plus or minus $5 million inclusive or exclusive of the annual reset at Permal?

Barry Bilson

Let me do the easy one first, Bill and please try and join us on time in the future. The guidance on the $35 million is a “normal” quarter. The $ 23 million of last year, again, we would hope a meaningful number that would occur this year would be on top of that. So that would be the base of the annual drop on top of that from a standpoint of your benchmark.

Relative to the distribution Bill, if you want to go through it in detail we can do it offline. I know what metric you are looking at, you are looking at the net distribution spread at about an 81% negative this quarter versus 75% last quarter. Again, the relationship of that distribution expense is not exclusively to the distribution and service fee revenue. You have to look at the fund revenue as well. A prime example is Permal who certainly grew in the quarter, average assets were meaningfully higher where they have no distribution fee revenue. It is a portion of their all-in management fee that is disbursed.

If you utilize the metric that I think will work best for you, i.e. relating the distribution expense to the sum of advisory fee revenue on funds plus the distribution of service fee revenue, you are going to find that basically was identical sequentially, 41 spot, eight this quarter, 42.3 last quarter. So if you use about a 42 level it may creep up or down over time but it's not going to be moving multiple percentage points.

William Katz - Buckingham Research

Thanks, that is perfect, thank you. I am sorry for being tardy. Chip, I was curious as I look at the liquidity business, that was most surprising relative to my expectation and given what we have seen with some of your competitors and even what we saw on the retail fund flow data, can you give us a little background on what's happening there? Is it a non-U.S. issue? Is it a performance issue? What sort of plans are there to build that business?

Chip Mason

I don't really know. As you know, this is a newer business to us, not that we haven't been in it a long time but we were a tiny player up until the Citi acquisition. So to some extent, I suspect we are still on learning curves on this. But remember that our key distribution in this, is the Citibank channel. We are not out broadly on a marketing basis in the business other than through the Citibank channel. That could be a factor.

I don't know if we know the reason. The flows were basically flat and others I know have had some very strong flows in here. It could be related to performance; it could be related to the channel we have versus the channel others have. It could be related to pricing. I don't know if we know that answer. The numbers have remained fairly constant through the year and I answered you in probably the only way I can.

William Katz - Buckingham Research

Just curious on the institutional business, it looks like LAMCO actually outperformed point to point. Can you step back and talk a little bit about the pipeline today versus maybe last quarter or a year ago and were you seeing any kind of plus or minuses as you look forward?

Chip Mason

I don't know if I can answer that because I don't have last year's numbers here. I can tell you that our one mandate -- that has been funded is strong; probably at least as good as last quarter. A year go, unfortunately, Bill -- Barry can get it for you but I don't really know what they were a year ago.

I would say in that area we probably aren't seeing much, if any, change from what I can tell. If that is different we can certainly find out. I think that mandates have remained strong and that long-term bond business, which has always been the sweet spot of Western in that core area, appears to be more or less as usual.

Barry Bilson

Bill, just so my legal folks don't get irritated, if I give you something, I will give it to everybody. The current pipeline is strong, maybe not at an all-time high but certainly well above the average relative to last year; probably a little bit lighter. You may recall that the December '06 quarter was an exceptionally strong quarter, I think it was almost $12 billion of inflow, not wholesale different, but probably not quite as high as a year ago.

Operator

Your next question comes from Robert Lee - KBW.

Robert Lee - KBW

My first question is related to the flows and to the business of Smith Barney and Citi. Is it possible to get any kind of better color on where you are seeing the real outflows there? Is it in the rack product? Is it in the fund products? It would be particularly helpful maybe to get a sense of even the products that are performing well? Are you seeing outflows in those from Smith Barney just as they migrate to other products and deemphasize the Legg Mason Partners products because they have so much of it?

Chip Mason

Well, that is the key right there. The outflows, I'd like to say to you that we believe we've troughed on the mutual funds side, and I think we do believe that; but the truth is, we don't know. We'll see, but the numbers do appear on the mutual funds side to have settled in a pattern that it feats to grow; in fact, it maybe even shrinks a little bit. So we are hopeful that there is a sign that we are reaching the lowest or lower ends of those flows.

In the separate account area, the SMA, those flows have continued and might even be up a little bit, but not appreciably. We don't know the length of this. Our view was that we would have them for two years or more. Right now we are probably bleeding in the more as much as anything else, because we are approaching two years.

As I've said before, I think performance is the answer to this and we have signs of better performance so that would certainly help if that kicked in. Most of this, I believe, is the separation of companies. By that, I mean this was fundamentally the Smith Barney product. It was part of them. It was part of the same entity. Whenever you see this happen and they go to a broader open architecture -- and that's too broad of a way to describe this, but to try and get my point across -- you see a wider outflow on what was the product that they had because they are purchasing more of the newer products that are coming in. So you are really not getting incoming flows. What you are doing is fighting to just hold on to what you have.

I think that is in fact what's going on here and as the SMA platforms broaden and they have more and more new people on the platform, the platform that was Smith Barney’s which is now Clearbridge isn't getting the preferred flows that they did before. Somewhere, that will go away. I can't tell you where. We are encouraged because it does not appear, at least on the mutual funds side, to be going south any more. It appears to have leveled and maybe even turned a little better. We'll see. All we can do on this is just keep you advised.

I do believe and have said all along that the only thing that will help us is performance. If you went back, because we looked at this for all the major brokerage firms, and looked at what their participation was within their firm of their own funds versus other funds, what percentage of the totals they got, they all went through a pretty dramatic reduction from maybe the low to mid 30s down to the high teens. Fortunately or unfortunately -- I think unfortunately for us -- during that period where some of the major firms had their big fall off, Citi held up better than most because their performance at that time was better than everybody. I know when we were doing the study, they had the best numbers, which did surprise us. I don't mean that in any wrong way. We just didn't realize that their numbers had been as strong as they were during that period which in the ten-year numbers I gave you, we included Citi in that number and at that point over ten years, 86% of their funds out performed and in five years, 76%. So you can see their numbers really, up until this recent period, had been pretty strong. Their outflows really came later and unfortunately we probably got most of that burden.

Hopefully that answers you because I don't think anybody really knows the answer.

Robert Lee - KBW

No, that's helpful. A follow-up question on Permal. If I recall you should have a contingent payment coming up, I guess this quarter. Can you just remind us about the size of that?

Chip Mason

$240 million. It is paid somewhere between November 1 and November 30 or something like that. It's very soon, you're right.

Robert Lee - KBW

Part of that you can pay in stock, too, I believe?

Chip Mason

Yes. At the current time we are looking to pay it in cash. We will see.

Robert Lee - KBW

I assume that will increase the intangible amortization as well as some of the tax benefit?

Chip Mason

No, it won't.

Robert Lee - KBW

No, it won't? I'm sorry, could you repeat that?

Barry Bilson

Effectively, Rob, the entirety was booked from an accounting perspective; it is really viewed almost as an installment obligation in the mix. What you see in the financials is reflective of 100%.

Operator

Our next question or comment comes from the line of Ms. Cynthia Mayer - Merrill Lynch.

Cynthia Mayer - Merrill Lynch

Good morning. I am just wondering if you can update us a little bit on the search for an international equity firm and remind us again of the size you are looking for and anything we should know about the timeline on that?

Also, I am wondering, maybe somebody asked this already but, if you know if Citigroup has sold any of its shares, how many they still have?

Chip Mason

I will take the last one first, because the answer is not to my knowledge, they own about 6% if I remember.

Barry Bilson

8.5 million shares.

Chip Mason

I don't think they've sold any more shares, but truly I don't know. They had to get under 10%; supposedly because of banking rules. To my knowledge, what they've sold is it. I mean, they haven't sold more. But we have no reason to track that. It's their call.

I probably have been doing this with the international equity firm for four or five years. We have seen three or four firms that we find extremely interesting over that period; maybe four or five. We have a couple firms that we certainly have interest in now. I have absolutely no idea when, if, how and probably even if I did, I couldn't tell you or wouldn't tell you. I really have nothing else I can say on that other than our interest remains there.

Cynthia, just to put this in perspective, we are underweighted, as you are well aware, on the international equity side, which has hurt us during the past several years and we are very cognizant of that. We are going to continue our quest, certainly not on the fixed income side, we don't have that issue, but on the equity side. It is part of our long-term plan to be moving in that direction. Some of our own managers now have gone deeper into that space. Brandywine as an example has over $10 billion in basically international equity product and their bond funds which are now $25 billion to $30 billion are virtually all directed in that direction.

We are having more shift even internally, because we are following where the money is and where the interest is.

Operator

Our next question or comment comes from the line of Prashant Bhatia - Citigroup.

Prashant Bhatia – Citigroup

In the release you talked about 7,000 or 8,000 new advisory relationships that you've got since the beginning of the year. Can you give us a feel for the flows that you're seeing from those new relationships and maybe talk about the two or three key products that are of interest to those new relationships?

Chip Mason

I think what we are talking about there, these are brokers. The way we count this, and we do this on a 12-month cycle, meaning if somebody doesn't put a ticket in for 12 months they go off the list. But every time a broker drops a ticket in a 12-month cycle that means they have used our product and we record that as a new advisor. Because typically, if they will put in one ticket you have a very high probability that will you get more business from them. So most of you will find that many of these distribution organizations in all of the firms do count new tickets, by new ticket meaning the first time that broker has put in a ticket. That is what that's indicating.

Prashant Bhatia – Citigroup

What are those new tickets tending to be for, what type of product?

Chip Mason

I think it's pretty much across the board. We are trying to see if there is any trending to it, but at least to my knowledge, or at least what the distribution people are telling me, it is not significant enough in any given area. We did get a fair amount of tickets on the Western funds because they had the numbers and it gave the broker a second place to be putting money. That was certainly something that we saw a lot of tickets on. Other than that, I would say there's probably nothing significant. Some of the funds that are performing well are beginning to see tickets. But if I told you anything more than that, I probably would be misleading you because it doesn't mean anything there.

Prashant Bhatia – Citigroup

On the share repurchases, Chip, you said in the past when you do a repurchase you really want to move the needle, you don't want to do small amounts. Should we take, based on the million shares that you've done, you are just getting started here or how should we interpret that?

Chip Mason

What I said on moving the needle was when we made an acquisition, if we made one, it would have to be big enough. I think we are talking about it would probably have to be $1 billion or more just because it wouldn't move the needle. I mean, if we did a smaller manager and it was $300 million, it wouldn't move the needle. If we made an acquisition that was probably going to be $1 billion or $2 billion in costs because if we didn't do it, we wouldn't be moving the needle. We wouldn't see it in earnings for quite some time, so that was the point.

On the shares -- and I made the comment in relationship to shares because I said that if we did an acquisition we probably couldn’t do both; we couldn’t be buying shares and make a major acquisition because as the board views this, that would be double leverage meaning we would be borrowing on the one side and buying shares.

Our share repurchase program, which the board is now comfortable with in a general sense, probably is not going to speed up appreciably. I think the board’s comfort level, as we begin to pay the debt down that we currently have, will go up. Remember we still have, as we mentioned before, a $240 million payment to Permal in November and we have $420 million, I think it is, of debt coming due in June. So we have some pretty big cash payments. Granted, our cash flow is there but you can only stretch it so many ways.

So at the moment, I would say the pattern that we are in, I wish we were a year from now because our pattern would potentially be a lot different. But until we continue to get things paid down and paid off, I don't have to deal with you as analysts but I have to deal with the board on the other side. I have one side that feels as though we are moving too fast and the other side that doesn't feel we are moving fast enough.

Prashant Bhatia – Citigroup

Just on the European acquisition, you are looking for a CEO at the same time. Is this something that you would wait to at least get a CEO in place before you went ahead with something like that, or are you comfortable just doing an acquisition before getting a CEO in place?

Chip Mason

This one has two sides to it. I think that's a very good fundamental point. Certainly the company you're going to acquire might hesitate because they might want to know who the new CEO is going to be. So from the standpoint of the company to be acquired, that's an issue, because I know a number of our managers keep telling me, well you could just be here, even if you don't have to handle all this stuff on a day-to-day basis, just be here. Who knows if that's going to happen? So that's a normal question coming from a potential acquisition.

The thing I would say to you is, in our history up until we did Citi, we never did an integration of any consequence. Everything we did was in the vernacular, a [inaudible] so you didn’t even know it happened. We just owned the company and then they went on and we went on as we were. I do not envision us doing anything that would cause any internal issues in terms of having to do systems.

I mean, when we did Permal as an example, or Royce or whatever, they already had all of that, and I would envision this to be the same. The only issue I think that could come up is I don't think from our side to wait because I think the board’s view would be that it's probably just as well as if I handled that. But I could see the other side hesitate.

Operator

Your next question comes from Michael Hecht - Banc of America Securities.

Michael Hecht - Banc of America Securities

Can I get a little bit more attribution across the equity outflows you saw? I mean $10 billion less the $2 billion, is it possible to get a better sense of how much was Clearbridge versus Legg Mason Capital Management versus Private Capital Management and how much may be offset by inflows into Royce and Brandywine and Permal? Is it also possible to get a sense of where the assets ended at the quarter at Clearbridge versus Legg Mason, some of the trouble areas?

Chip Mason

They are pretty much even. Clearbridge is certainly not the largest, if that's the base of your question. The issue, it's really those outflows and we listed them as equity outflows of $2 billion. The whole outflow was $3 billion because $1 billion of it, which was in this pension fund -- I guess it wasn't a pension fund -- the company went to an open platform.

I would say they are pretty much even across the board. It may be 40/30/30 or 40/32/28 or something like that, but it's not dramatically different. If you take the outflows leaving the pension fund alone.

What was the rest of your question?

Michael Hecht - Banc of America Securities

I was trying to get a sense as to at the end of the quarter, how much of a change or where the assets ended the quarter across the different fund complexes?

Chip Mason

We haven't normally given those out. Clearbridge is down a touch. They are actually, it is an interesting thing. I think Clearbridge during this whole cycle obviously the market has responded to them, maybe because of flows, maybe off 2% in total assets. It really isn't down much at all. Their total assets are within 2% or 3% of where they were a year ago or six months ago.

The theory that their assets are down a lot is really just inaccurate. That would be maybe a little less true in some of the others. On the other hand, we have other managers that are off, but it has been pretty even. I mean the discussions are always around Clearbridge which is a little unfair to them, because they are getting more the brunt of this than the facts are.

Michael Hecht - Banc of America Securities

Assets like Legg Mason Capital Management and Private Capital Management, are those down a bit quarter over quarter?

Chip Mason

Yes.

Michael Hecht - Banc of America Securities

Flows that you are seeing into Royce and Batterymarch, how have those held up?

Chip Mason

Generally pretty decent but slow downs in some of them. Certainly if Brandywine continues to have relatively strong flows, a lot of it is institutional so it gets much lumpier. Meaning you all, when you're commenting to me very often -- I don't mean you specifically but just in general -- the only numbers you can get are these retail fund numbers. Our numbers are very skewed, as you know, by institutional because it's the bulk of our assets and those numbers tend to come in much lumpier because they are based on when the bids go out and it doesn't happen every day or every week. You may have one week where you took in $6 million; you may go two weeks where you take in $100 million here and $200 million there.

In the case of say Brandywine, institutional is extremely important to them and they do come in very lumpy and big. That would be true of many of our managers that aren't totally into the mutual fund business. Royce would be different in the fact that their business is heavy mutual funds. They are up year over year. They are probably quarter over quarter either flat or down a little bit.

Barry Bilson

Mike, I understand what you are trying to get to, but we have never micro-detailed the stuff. The comment that we made in the midst of it is there is really not an escalation, not to repeat, but obviously we had a couple of situations of magnitude that certainly were outflows but really one-off.

The other dynamic is it gives some optic here that may make you a little uncomfortable, and I think it's part of what you're trying to get to. There is not an escalation of any magnitude in the outflow in the big three equity managers but there is a bit of easing in the inflow into the small cap space industry-wide and we are participating in that. With the disruption in the marketplace in the September quarter, there was some easing of the inflow into the hedge fund and the fund to fund space.

It's still positive, but it was not as strong as a couple of the preceding quarters. So when you don't have the benefit as strong and positive number on a couple of the managers, it tends to make the total look not as solid.

Michael Hecht - Banc of America Securities

That's helpful. Just one last quick question on the balance sheet. You ended the quarter with $400 million of net cash. How should we think about how much cash you actually have available at the parent or excess that's available for repurchasing stock, et cetera?

Barry Bilson

Probably about $500 million but again, remember we have some contingent payments coming up; we have $240 million right around the quarter.

Michael Hecht - Banc of America Securities

And then whatever debt you guys talked about that you do each month?

Barry Bilson

Each quarter.

Operator

Your next question comes from Douglas Sipkin - Wachovia.

Douglas Sipkin - Wachovia

Chip and Barry, you guys seemed to indicate that you felt -- obviously no one knows for sure -- but that the outflows for equities were stabilizing a little bit. At least initially you have that feel. I'm just wondering in the context of obviously the long-term performance of the Legg funds is undisputed, but it's been several years now. It feels like we are moving to more of a three or four-year time period where the performance is not as good as it is has been historically.

I'm just curious, do you guys feel comfortable that won't have somewhat of a more longer term impact on people's view towards the products, in light of your comments that you felt like outflows were starting to slow a little bit?

Chip Mason

Doug first of all, you have to always separate from what our wishes and hopes are and what the realities are. Sometimes, I constantly give myself a reality check against my hopes and desires. It's impossible for us to know this. The signs that we're seeing are encouraging and we don't want to promote it. We don't want to beat the drums because it could go the other way in the next three months. We did anticipate for a couple of years that because the Smith Barney funds were no longer Smith Barney funds -- which would be true of any situation probably of this nature -- that if you had strong performance during this period a lot of these issues wouldn't be around, but if you had weak performance during the period you would have an issue because the separation means you have a likelihood to have outflows. This was a purchase. It was a separation.

I was trying to speak to that more than the performance side. I do think the performance side certainly affects it, but I think the factual side of the separation is a real factor in this as well.

Douglas Sipkin - Wachovia

I know you mentioned in reference to the Citigroup shares, it's completely their call. Are you guys at least concerned maybe just from the standpoint of the changing of the distribution relationship that maybe they don't have as much of a invested interest in you guys doing as well or am I reading too much into that?

Barry Bilson

You are reading too much into it.

Chip Mason

I don't see this as an issue at all. I mean they may sell, they may not sell. I doubt if they do sell. We have institutional holders that are larger than their piece. So it's not a weighting overhang, but I really don't see them as a seller. I think that their feeling was that they should have some long-term interest in us and what we do and we certainly work with them in many, many, many ways, not just in this retail piece that you all see visibly.

I wouldn't be concerned about that; now watch, they will sell it tomorrow. I mean, there is no indication and I do talk to Chuck and Lou and others reasonably frequently and I don't think that's an issue.

Barry Bilson

They are a key strategic partner in the distribution for us and it was a very amicable arrangement. They still do have the exclusivity in place on the primary share plays as the retail share player. They have some broadening capability outside of that but the relationship is as solid as ever and very important to us.

Operator

Ladies and gentlemen, this concludes our Q&A session at this time. I am going to return the conference back over to the panel.

Chip Mason

I'll just say in closing, because I know that you all have a call coming up that you're interested in getting on -- the analysts, that is -- and one thing I was going to say and Barry did say it is, really the difference in these earnings is performance fees and I assume you all could figure that out fairly quickly, were the performance fees what they were last quarter, you wouldn’t have had a differential.

I think you can see that by just looking at the numbers. As I indicated, we are encouraged by the equity performance, but it is really too soon to be confident. There are better signs things are better on some of the performance fronts, but time will tell this.

The other thing I wanted to just mention to you -- and I will do this from time to time with you is-- go back and take a look if you can at what the firm has done over the last four or five years. Very often I don't think we get the proper -- but if you look at our net income, five years ago for the first six months it was $119 million then $178 million and then $234 million and then $300 million then $368 million; that's in successive years. To go from $119 million to $368 million over that four-year period using '03 as a benchmark is no small feat. Earnings from $1.07 to $2.55, we have continuously marched along, sometimes not as broad and with as great of an increase as you want.

I use as a barometer very often what Barry refers to as the evolution of quarters. I've done this chart that some of you have seen where we take every quarter and show what we earn per share per quarter and we do this every year, religiously. If you take those quarters and just look at it we have, even during this cycle which has been a lot of work and we've absorbed a tremendous amount of cost without saying a whole lot about it, our average quarter in 2003 was $0.45 and in 2004 it was $0.56 and 2005 was $0.88 and 2006 was $0.96, and 2007 was $1.12. So far this year it's $1.28. That really is what we are supposed to be doing.

We obviously have had times with some bumps, but we’ve pretty much continued to move forward and as I said, maybe not as fast, but we give you pretty consistent numbers even at times when you don't think we are.

We always thank you for listening and appreciate your questions. Hopefully, we will talk to you again in the near future. Thank you.

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Source: Legg Mason F2Q08 (Qtr End 9/30/07) Earnings Call Transcript
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