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Legg Mason Inc.’s (LM - Analyst Report) fiscal second-quarter 2014 adjusted earnings came in at 85 cents per share, missing the Zacks Consensus Estimate by 8 cents. However, this came above the year-ago figure of 75 cents per share.

Lower-than-expected results were due to higher operating expenses. However, top-line growth, aided primarily by an increase in both investment advisory fees and other revenues was a tailwind. Further, increased assets under management (AUM) were a positive.

Adjusted net income came in at $104.5 million, compared with $10.1 million in the prior-year quarter. Including one-time items, Legg Mason reported net income of $86.3 million or 70 cents per share, compared with $80.8 million or 60 cents in the prior-year quarter.

Performance in Detail

Legg Mason’s total revenue came in at $669.9 million, up 5% year over year. The rise was due to an increase in average equity AUM and higher performance fees. Moreover, revenues surpassed the Zacks Consensus Estimate of $656.0 million.

Investment Advisory fees climbed 4.5% year over year to $581.6 million. Distribution and Service fees rose 5.3% to $86.2 million. Moreover, other revenues were up 11.9% year over year to $1.98 million.

Operating expenses inched up 0.5% to $563.5 million on a year-over-year basis. The rise was primarily due to increased distribution and servicing related expenses along with higher revenue share compensation mainly related to higher revenues.

Adjusted operating margin of Legg Mason was 22.3%, up from 21.9% in the prior-year quarter.

Assets Position

As of Sep 30, 2013, Legg Mason’s AUM was $656.0 billion, up 1% year over year from $650.7 billion.  Of the total AUM, fixed income constituted 54%, liquidity 20% and equity 26%.

Equity outflows were $4.0 billion, while fixed income and liquidity inflows were $0.3 billion and $2.3 billion, respectively for the quarter ended Sep 30, 2013. Additionally, average AUM was $650.4 billion, compared with $639.4 billion in the prior-year quarter.

Balance Sheet

As of Sep 30, 2013, Legg Mason had approximately $712 million in cash, in line with the prior quarter, while total debt was $1.1 billion, in line with the prior-quarter amount. Shareholders’ equity increased to $4.8 billion from $4.7 billion in the prior quarter.

The ratio of total debt to total capital (total equity plus total debt excluding consolidated investment vehicles) was 19%, in line with the prior quarter.

Capital Deployment Update

Concurrent with the earnings release, Legg Mason’s board of directors declared a quarterly cash dividend of 13 cents per share. The dividend will be paid on Jan 6, 2014 to shareholders of record as of Dec 11, 2013. Moreover, the company repurchased 2.7 million shares in the said quarter.

Competitive Landscape

Among other investment managers, Janus Capital Group Inc.’s (JNS - Analyst Report) September-quarter end earnings were in line with the Zacks Consensus Estimate, while results at T. Rowe Price Group, Inc. (TROW - Analyst Report) and Lazard Ltd. (LAZ - Analyst Report) beat the Zacks Consensus Estimate.

Our Viewpoint

We believe Legg Mason has the potential to outperform its peers in the long run, given its diversified product mix and leverage in the changing market demography. However, asset outflows will remain a significant headwind in the near term.

Nevertheless, with restructuring initiatives and cost-cutting measures, we expect operating efficiencies to improve, and dividend payments to continue boosting investors’ confidence in the stock. Legg Mason currently carries a Zacks Rank #3 (Hold).

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