XNYS:LM Legg Mason Inc Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
  
Washington, D.C.  20549
 
FORM 10-Q
(Mark One)
[x]  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2012
OR
[ ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from
 
 
 
to
 
Commission file number: 1-8529
 
LEGG MASON, INC.
(Exact name of registrant as specified in its charter)
 
 
 
MARYLAND
 
52-1200960
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
100 International Drive - Baltimore, MD
 
21202
(Address of principal executive offices)
 
(Zip code)
 
 
 
(410) 539-0000
(Registrant’s telephone number, including area code)
 
 
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes
X
 
No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). 
Yes
X
 
No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
X
 
Accelerated filer
 
Non-accelerated filer
 
(Do not check if a smaller reporting company)
Smaller reporting company
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes
 
 
No
X
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
135,057,136 shares of common stock as of the close of business on August 2, 2012.




PART I. FINANCIAL INFORMATION
Item 1.         Financial Statements

LEGG MASON, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
(Unaudited)

 
 
June 30, 2012
 
March 31, 2012
ASSETS
 
 
 
 
Current Assets
 
 
 
 
Cash and cash equivalents
 
$
757,884

 
$
1,382,263

Cash and cash equivalents of consolidated investment vehicles
 
28,463

 
26,139

Restricted cash
 
2,575

 
2,167

Receivables:
 
 
 
 
Investment advisory and related fees
 
311,471

 
333,777

Other
 
44,104

 
100,060

Investment securities
 
345,505

 
412,119

Investment securities of consolidated investment vehicles
 
29,439

 
31,575

Deferred income taxes
 
109,486

 
117,391

Other
 
50,079

 
51,977

Total current assets
 
1,679,006

 
2,457,468

Fixed assets, net
 
232,401

 
239,411

Intangible assets, net
 
3,853,233

 
3,856,866

Goodwill
 
1,259,043

 
1,275,045

Investments of consolidated investment vehicles
 
297,129

 
294,853

Deferred income taxes
 
193,833

 
142,706

Other
 
282,853

 
287,653

Other assets of consolidated investment vehicles
 
1,509

 
1,745

Total Assets
 
$
7,799,007

 
$
8,555,747

 
 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
 

Liabilities
 
 

 
 

Current Liabilities
 
 

 
 

Accrued compensation
 
$
186,000

 
$
409,759

Accounts payable and accrued expenses
 
195,504

 
195,808

Short-term borrowings
 

 
250,000

Current portion of long-term debt
 
51,066

 
1,278

Other
 
62,432

 
114,840

Other current liabilities of consolidated investment vehicles
 
12,212

 
4,097

Total current liabilities
 
507,214

 
975,782

Deferred compensation
 
41,780

 
57,339

Deferred income taxes
 
225,717

 
242,567

Other
 
167,489

 
167,544

Other liabilities of consolidated investment vehicles
 
3,620

 
3,872

Long-term debt
 
1,101,735

 
1,135,614

Long-term debt of consolidated investment vehicles
 
273,560

 
271,707

Total Liabilities
 
2,321,115

 
2,854,425

 
 
 
 
 
Commitments and Contingencies (Note 8)
 


 


 
 
 
 
 
Redeemable Noncontrolling Interests
 
21,502

 
24,031

 
 
 
 
 
Stockholders’ Equity
 
 
 
 
Common stock, par value $.10; authorized 500,000,000 shares; issued 135,030,081 shares and 139,874,034 shares, respectively
 
13,503

 
13,987

Additional paid-in capital
 
3,684,690

 
3,864,216

Employee stock trust
 
(32,991
)
 
(32,419
)
Deferred compensation employee stock trust
 
32,991

 
32,419

Retained earnings
 
1,690,451

 
1,715,395

Appropriated retained earnings for consolidated investment vehicle
 
9,356

 
12,221

Accumulated other comprehensive income, net
 
58,390

 
71,472

Total Stockholders’ Equity
 
5,456,390

 
5,677,291

Total Liabilities and Stockholders’ Equity
 
$
7,799,007

 
$
8,555,747

See Notes to Consolidated Financial Statements

2



LEGG MASON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
(Dollars in thousands, except per share amounts)
(Unaudited)


 
 
Three Months Ended
 
 
June 30,
 
 
2012
 
2011
Operating Revenues
 
 
 
 
Investment advisory fees:
 
 
 
 
Separate accounts
 
$
182,436

 
$
204,793

Funds
 
356,474

 
400,144

Performance fees
 
8,566

 
18,614

Distribution and service fees
 
81,623

 
92,064

Other
 
1,593

 
1,493

Total operating revenues
 
630,692

 
717,108

Operating Expenses
 
 
 
 
Compensation and benefits
 
270,262

 
300,352

Transition-related compensation
 

 
11,395

Total compensation and benefits
 
270,262

 
311,747

Distribution and servicing
 
169,825

 
180,756

Communications and technology
 
37,630

 
40,501

Occupancy
 
30,252

 
33,238

Amortization of intangible assets
 
3,505

 
5,578

Other
 
43,141

 
44,922

Total operating expenses
 
554,615

 
616,742

Operating Income
 
76,077

 
100,366

Other Non-Operating Income (Expense)
 
 
 
 
Interest income
 
1,936

 
3,055

Interest expense
 
(19,227
)
 
(22,361
)
Other income (expense), net, including $68,975 debt extinguishment loss in 2012
 
(72,633
)
 
3,403

Other non-operating income (loss) of consolidated investment vehicles, net
 
(4,134
)
 
5,102

Total other non-operating expense
 
(94,058
)
 
(10,801
)
Income (Loss) Before Income Tax Provision (Benefit)
 
(17,981
)
 
89,565

Income tax provision (benefit)
 
(4,997
)
 
27,867

Net Income (Loss)
 
(12,984
)
 
61,698

Less: Net income (loss) attributable to noncontrolling interests
 
(3,526
)
 
1,746

Net Income (Loss) Attributable to Legg Mason, Inc.
 
$
(9,458
)
 
$
59,952

 
 
 
 
 
Net Income (Loss) per Share Attributable to Legg Mason, Inc. Common Shareholders:
 
 
 
 
Basic
 
$
(0.07
)
 
$
0.40

Diluted
 
$
(0.07
)
 
$
0.40

 
 
 
 
 
Weighted Average Number of Shares Outstanding
 
 
 
 
Basic
 
138,720

 
149,210

Diluted
 
138,720

 
149,347

 
 
 
 
 
Dividends Declared per Share
 
$
0.11

 
$
0.08

See Notes to Consolidated Financial Statements

3



LEGG MASON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Dollars in thousands, except per share amounts)
(Unaudited)



 
 
Three Months Ended
 
 
June 30,
 
 
2012
 
2011
Net Income (Loss)
 
$
(12,984
)
 
$
61,698

Other comprehensive income (loss):
 
 
 


Foreign currency translation adjustment
 
(13,135
)
 
13,360

Unrealized gains on investment securities:
 
 
 


Unrealized holding gains, net of tax provision of $41, and $44, respectively
 
62

 
67

Reclassification adjustment for (gains) losses included in net income (loss)
 
(9
)
 
4

Net unrealized gains on investment securities
 
53

 
71

Total other comprehensive income (loss)
 
(13,082
)
 
13,431

Comprehensive Income (Loss)
 
(26,066
)
 
75,129

Less: Comprehensive income (loss) attributable to noncontrolling interests
 
(3,526
)
 
1,746

Comprehensive Income (Loss) Attributable to Legg Mason, Inc.
 
$
(22,540
)
 
$
73,383

See Notes to Consolidated Financial Statements

4



LEGG MASON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(Dollars in thousands)
(Unaudited)


 
 
Three Months Ended June 30,
 
 
2012
 
2011
COMMON STOCK
 
 
 
 
Beginning balance
 
$
13,987

 
$
15,022

Stock options and other stock-based compensation
 
1

 
2

Deferred compensation employee stock trust
 
3

 
3

Deferred compensation, net
 
158

 
116

Equity Units exchanged
 

 
183

Employee tax withholdings by net share transactions
 
(29
)
 

Shares repurchased and retired
 
(617
)
 
(603
)
Ending balance
 
13,503

 
14,723

ADDITIONAL PAID-IN CAPITAL
 
 

 
 

Beginning balance
 
3,864,216

 
4,111,095

Stock options and other stock-based compensation
 
3,327

 
4,894

Deferred compensation employee stock trust
 
831

 
1,060

Deferred compensation, net
 
9,145

 
7,965

Equity Units exchanged
 

 
102,856

Employee tax withholdings by net share transactions
 
(7,613
)
 

Shares repurchased and retired
 
(154,383
)
 
(199,516
)
Allocation from 2.5% Convertible Senior Notes repurchase, net of tax
 
(30,833
)
 

Ending balance
 
3,684,690

 
4,028,354

EMPLOYEE STOCK TRUST
 
 

 
 

Beginning balance
 
(32,419
)
 
(34,466
)
Shares issued to plans
 
(834
)
 
(1,063
)
Distributions and forfeitures
 
262

 
679

Ending balance
 
(32,991
)
 
(34,850
)
DEFERRED COMPENSATION EMPLOYEE STOCK TRUST
 
 

 
 

Beginning balance
 
32,419

 
34,466

Shares issued to plans
 
834

 
1,063

Distributions and forfeitures
 
(262
)
 
(679
)
Ending balance
 
32,991

 
34,850

RETAINED EARNINGS
 
 

 
 

Beginning balance
 
1,715,395

 
1,539,984

Net income (loss) attributable to Legg Mason, Inc.
 
(9,458
)
 
59,952

Dividends declared
 
(15,486
)
 
(12,184
)
Ending balance
 
1,690,451

 
1,587,752

APPROPRIATED RETAINED EARNINGS FOR CONSOLIDATED INVESTMENT VEHICLE
 
 

 
 

Beginning balance
 
12,221

 
10,922

Net loss reclassified to appropriated retained earnings
 
(2,865
)
 
(2,145
)
Ending balance
 
9,356

 
8,777

ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS), NET
 
 

 
 

Beginning balance
 
71,472

 
93,361

Net unrealized holding gains on investment securities
 
53

 
71

Foreign currency translation adjustment
 
(13,135
)
 
13,360

Ending balance
 
58,390

 
106,792

TOTAL STOCKHOLDERS’ EQUITY
 
$
5,456,390

 
$
5,746,398


See Notes to Consolidated Financial Statements

5



LEGG MASON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)
 
 
Three Months Ended
 

June 30,
 

2012

2011
Cash Flows from Operating Activities
 
 
 
 
Net Income (Loss)
 
$
(12,984
)
 
$
61,698

2.5% Convertible Senior Notes:
 
 
 
 
Allocation of repurchase payment
 
(216,038
)
 

Loss on extinguishment
 
68,975

 

Adjustments to reconcile Net Income (Loss) to net cash provided by operations:
 
 
 
 
Depreciation and amortization
 
17,079

 
22,879

Imputed interest for 2.5% Convertible Senior Notes
 
5,839

 
9,489

Accretion and amortization of securities discounts and premiums, net
 
1,101

 
1,147

Stock-based compensation
 
12,734

 
12,431

Net losses on investments
 
4,628

 
177

Net losses (gains) of consolidated investment vehicles
 
4,913

 
(3,538
)
Deferred income taxes
 
(8,659
)
 
4,067

Other
 
549

 
533

Decrease (increase) in assets:
 
 
 
 
Investment advisory and related fees receivable
 
22,142

 
15,763

Net sales of trading and other current investments
 
67,202

 
20,635

Other receivables
 
5,033

 
(6,993
)
Other assets
 
155

 
7,713

Increase (decrease) in liabilities:
 
 
 
 
Accrued compensation
 
(223,135
)
 
(115,161
)
Deferred compensation
 
(15,559
)
 
(25,786
)
Accounts payable and accrued expenses
 
(260
)
 
106

Other liabilities
 
(20,690
)
 
22,694

Net increase (decrease) in operating assets and liabilities of consolidated investment vehicles, including cash
 
7,435

 
(103,751
)
Cash Used in Operating Activities
 
(279,540
)
 
(75,897
)
Cash Flows from Investing Activities
 
 

 
 

Payments for fixed assets
 
(7,461
)
 
(8,133
)
Restricted cash
 
(408
)
 
1,617

Purchases of investment securities
 
(2,225
)
 
(1,630
)
Proceeds from sales and maturities of investment securities
 
1,961

 
1,723

Purchases of investments by consolidated investment vehicles
 
(59,877
)
 
(56,831
)
Proceeds from sales and maturities of investments by consolidated investment vehicles
 
55,387

 
71,357

Cash Provided by (Used in) Investing Activities
 
$
(12,623
)
 
$
8,103


6



LEGG MASON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)

 
 
Three Months Ended
 

June 30,
 

2012

2011
Cash Flows from Financing Activities
 
 
 
 
Repayment of short-term borrowings
 
$
(250,000
)
 
$

Repayment of 2.5% Convertible Senior Notes, net of operating allocation
 
(1,040,212
)
 

Repayment of long-term debt
 
(425
)
 
(195
)
Proceeds from issuance of long-term debt
 
1,143,246

 

Debt issuance costs
 
(8,498
)
 

Issuance of common stock
 
729

 
1,133

Repurchase of common stock
 
(162,642
)
 
(200,119
)
Dividends paid
 
(11,178
)
 
(9,144
)
Net repayments of consolidated investment vehicles
 

 
82,727

Net (redemptions/distributions paid to)/subscriptions received from noncontrolling interest holders
 
(1,868
)
 
7,388

Cash Used in Financing Activities
 
(330,848
)
 
(118,210
)
Effect of Exchange Rate Changes on Cash
 
(1,368
)
 
6,105

Net Decrease in Cash and Cash Equivalents
 
(624,379
)
 
(179,899
)
Cash and Cash Equivalents at Beginning of Period
 
1,382,263

 
1,375,918

Cash and Cash Equivalents at End of Period
 
$
757,884

 
$
1,196,019



See Notes to Consolidated Financial Statements
  


7



LEGG MASON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts or unless otherwise noted)
June 30, 2012
(Unaudited)


1.
Interim Basis of Reporting

The accompanying unaudited interim consolidated financial statements of Legg Mason, Inc. and its subsidiaries (collectively “Legg Mason”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and the applicable rules and regulations of the Securities and Exchange Commission (the "SEC"). The interim consolidated financial statements have been prepared using the interim basis of reporting and, as such, reflect all adjustments (consisting only of normal recurring adjustments) which are, in the opinion of management, necessary for a fair statement of the results for the periods presented. The preparation of interim consolidated financial statements requires management to make assumptions and estimates that affect the amounts reported in the interim consolidated financial statements and accompanying notes. Actual amounts could differ from those estimates and the differences could have a material impact on the interim consolidated financial statements.

The nature of our business is such that the results of any interim period are not necessarily indicative of the results of a full year. The fiscal year-end condensed balance sheet was derived from audited financial statements and, in accordance with interim financial information standards, does not include all disclosures required by U.S. GAAP for annual financial statements. Certain amounts in prior period financial statements have been reclassified to conform to the current period presentation.

The information contained in the interim consolidated financial statements should be read in conjunction with our latest Annual Report on Form 10-K filed with the SEC.

Terms such as “we,” “us,” “our,” and “Company” refer to Legg Mason.

2.
Significant Accounting Policies

Consolidation
In accordance with financial accounting standards on consolidation, Legg Mason consolidates and separately identifies certain sponsored investment vehicles, the most significant of which is a collateralized loan obligation entity (“CLO”).  The consolidation of these investment vehicles has no impact on Net Income (Loss) Attributable to Legg Mason, Inc. and does not have a material impact on Legg Mason's consolidated operating results.  The change in the value of these consolidated investment vehicles, which is recorded in Other non-operating income (expense), is reflected in its Net Income (Loss), net of amounts allocated to noncontrolling interests.  Also, see Note 12 for additional information regarding the consolidation of investment vehicles.

Restructuring Costs
In May 2010, Legg Mason's management committed to a plan to streamline its business model as further described in Note 11. The streamlining initiative was complete as of March 31, 2012. The costs associated with this initiative primarily related to employee termination benefits, incentives to retain employees during the transition period, charges for consolidating leased office space, and contract termination costs. Termination benefits, including severance and retention incentives, were recorded as Transition-related compensation in the Consolidated Statements of Income (Loss). These compensation items required employees to provide future service and were therefore expensed ratably over the required service period. Contract termination and other costs were expensed when incurred.

New Capital Plan
In May 2012, Legg Mason implemented a new capital plan for the refinancing/restructuring of debt and the acceleration/increase of share repurchase authorizations. As a result, Net Income (Loss) Attributable to Legg Mason, Inc. for the three months ended June 30, 2012, includes a pre-tax loss on debt extinguishment of $68,975 and a net reduction in outstanding debt obligations of $350,000. See Notes 6 and 9 for further details.


8



Income Taxes
During the three months ended June 30, 2012, the effective benefit rate of 27.8% includes a reduction of 7.2% from the impact of consolidated investment vehicles ("CIVs"), which increases Net Income (Loss) Before Income Tax Provision (Benefit), but has no related Income tax provision (benefit).

Noncontrolling Interests
Noncontrolling interests related to CIVs are classified as redeemable noncontrolling interests if investors in these funds may request withdrawals at any time. There are no nonredeemable noncontrolling interests as of June 30, 2012, March 31, 2012, or June 30, 2011. As noted above, Net income (loss) attributable to noncontrolling interests in the Consolidated Statements of Income also includes Net income (loss) reclassified to Appropriated retained earnings for consolidated investment vehicle in the Consolidated Balance Sheets.

Net income (loss) attributable to noncontrolling interests for the three months ended June 30, 2012 and 2011 included the following amounts:
 
 
Three Months Ended June 30,
 
 
2012
 
2011
Net income (loss) attributable to redeemable noncontrolling interests
 
$
(661
)
 
$
3,891

Net loss reclassified to Appropriated retained earnings for consolidated investment vehicle
 
(2,865
)
 
(2,145
)
Total
 
$
(3,526
)
 
$
1,746


Redeemable noncontrolling interests as of and for the three months ended June 30, 2012 and 2011, were as follows:
 
 
Three Months Ended June 30,
 
 
2012
 
2011
Balance, beginning of period
 
$
24,031

 
$
36,712

Net income (loss) attributable to redeemable noncontrolling interests
 
(661
)
 
3,891

Net (redemptions/distributions paid to)/subscriptions received from noncontrolling interest holders
 
(1,868
)
 
7,388

Balance, end of period
 
$
21,502

 
$
47,991


Recent Accounting Developments
In July 2012, the FASB updated the guidance on the annual indefinite-lived intangible asset tests for impairment. The update permits companies to assess qualitative factors to determine if it is more likely than not that the fair value of the intangible asset is less than its carrying amount as a basis for determining whether it is necessary to perform the currently required quantitative fair value assessment. This update will be effective for Legg Mason in fiscal 2014, if not adopted early. This update is not expected to have a material effect on its recorded indefinite-lived assets, and Legg Mason is still evaluating its adoption.

3. Fair Values of Assets and Liabilities

The disclosures below include details of Legg Mason's assets and liabilities that are measured at fair value, excluding the assets and liabilities of CIVs. See Note 12, Variable Interest Entities and Consolidation of Investment Vehicles, for information related to the assets and liabilities of CIVs that are measured at fair value.


9



The fair values of financial assets and (liabilities) of the Company were determined using the following categories of inputs:
 
 
As of June 30, 2012
 
 
Quoted prices in active markets
(Level 1)
 
Significant other observable
inputs
(Level 2)
 
Significant unobservable inputs
(Level 3)
 
Total
Assets:
 
 
 
 
 
 
 
 
Cash equivalents(1):
 
 
 
 
 
 
 
 
Money market funds
 
$
428,517

 
$

 
$

 
$
428,517

Time deposits
 

 
90,791

 

 
90,791

Total cash equivalents
 
428,517

 
90,791

 

 
519,308

Investment securities:
 
 

 
 

 
 

 
 

Trading investments relating to long-term incentive compensation plans(2)
 
91,152

 

 

 
91,152

Trading proprietary fund products and other investments(3)
 
116,446

 
80,802

 

 
197,248

Equity method investments relating to long-term incentive compensation plans, proprietary fund products and other investments(4)(5)
 
11,586

 
34,223

 
11,296

 
57,105

Total current investments
 
219,184

 
115,025

 
11,296

 
345,505

Available-for-sale investment securities
 
2,108

 
10,138

 
12

 
12,258

Investments in partnerships, LLCs and other
 
751

 
2,646

 
28,513

 
31,910

Equity method investments in partnerships and LLCs(4)
 
1,322

 
3

 
160,602

 
161,927

Derivative assets:
 
 
 
 
 


 
 

Currency and market hedges
 
1,129

 

 

 
1,129

Other investments
 

 

 
116

 
116

 
 
$
653,011

 
$
218,603

 
$
200,539

 
$
1,072,153

Liabilities:
 
 
 
 
 
 
 
 
Derivative liabilities:
 
 
 
 
 
 
 
 
Currency and market hedges
 
$
(762
)
 
$

 
$

 
$
(762
)



10



 
 
As of March 31, 2012
 
 
Quoted prices in active markets
(Level 1)
 
Significant other observable inputs
(Level 2)
 
Significant unobservable inputs
(Level 3)
 
Total
Assets:
 
 
 
 
 
 
 
 
Cash equivalents(1):
 
 
 
 
 
 
 
 
Money market funds
 
$
893,738

 
$

 
$

 
$
893,738

Time deposits
 

 
88,289

 

 
88,289

Total cash equivalents
 
893,738

 
88,289

 

 
982,027

Investment securities:
 
 

 
 

 
 

 
 

Trading investments relating to long-term incentive compensation plans(2)
 
111,257

 

 

 
111,257

Trading proprietary fund products and other investments(3)
 
143,002

 
79,583

 

 
222,585

Equity method investments relating to long-term incentive compensation plans, proprietary fund products and other investments(4)(5)
 
11,565

 
54,934

 
11,778

 
78,277

Total current investments
 
265,824

 
134,517

 
11,778

 
412,119

Available-for-sale investment securities
 
2,091

 
9,810

 
12

 
11,913

Investments in partnerships, LLCs and other
 
851

 
5,351

 
28,763

 
34,965

Equity method investments in partnerships and LLCs(4)
 
1,415

 
1,348

 
166,438

 
169,201

Derivative assets:
 
 
 
 
 
 
 
 

Currency and market hedges
 
84

 

 

 
84

Other investments
 

 

 
112

 
112

 
 
$
1,164,003

 
$
239,315

 
$
207,103

 
$
1,610,421

Liabilities:
 
 

 
 

 
 

 
 

Derivative liabilities:
 
 

 
 

 
 

 
 

Currency and market hedges
 
$
(886
)
 
$

 
$

 
$
(886
)
(1)
Cash equivalents include highly liquid investments with original maturities of 90 days or less. Cash investments in actively traded money market funds are measured at net asset value ("NAV") and are classified as Level 1.  Cash investments in time deposits are measured at amortized cost, which approximates fair value because of the short time between the purchase of the instrument and its expected realization, and are classified as Level 2.
(2)
Primarily mutual funds where there is minimal market risk to the Company as any change in value is primarily offset by an adjustment to compensation expense and related deferred compensation liability.
(3)
Trading proprietary fund products and other investments primarily represent mutual funds that are invested approximately 54% and 46% in equity and debt securities as of June 30, 2012, respectively, and were invested approximately 52% and 48% in equity and debt securities as of March 31, 2012, respectively.
(4)
Substantially all of Legg Mason's equity method investments are investment companies which record their underlying investments at fair value.  Fair value is measured using Legg Mason's share of the investee's underlying net income or loss, which is predominately representative of fair value adjustments in the investments held by the equity method investee.
(5)
Includes investments under the equity method (which approximates fair value) relating to long-term incentive compensation plans of $34,223 and $54,934 as of June 30, 2012 and March 31, 2012, respectively, and proprietary fund products and other investments of $22,881 and $23,343 as of June 30, 2012 and March 31, 2012, respectively, which are classified as Investment securities on the Consolidated Balance Sheets.

Substantially all of the above financial instruments where valuation methods rely on other than observable market inputs as a significant input utilize the equity method, the cost method, or NAV practical expedient, such that measurement uncertainty has little relevance.


11



The changes in financial assets measured at fair value using significant unobservable inputs (Level 3) for the three months ended June 30, 2012 and 2011, are presented in the table below:
 
 
Value as of March 31, 2012
 
Purchases
 
Sales
 
Settlements/ Other
 
Transfers
 
Realized and unrealized gains/(losses), net
 
Value as of June 30, 2012
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Equity method investments in proprietary fund products
 
$
11,778

 
$

 
$

 
$

 
$

 
$
(482
)
 
$
11,296

Investments in partnerships, LLCs and other
 
28,763

 

 

 
(151
)
 

 
(99
)
 
28,513

Equity method investments in partnerships and LLCs
 
166,438

 
90

 
(1,602
)
 
(5,614
)
 

 
1,290

 
160,602

Other investments
 
124

 

 

 

 

 
4

 
128

 
 
$
207,103

 
$
90

 
$
(1,602
)
 
$
(5,765
)
 
$

 
$
713

 
$
200,539


 
 
Value as of March 31, 2011
 
Purchases
 
Sales
 
Settlements/ Other
 
Transfers
 
Realized and unrealized gains/(losses), net
 
Value as of June 30, 2011
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Trading proprietary fund products and other investments
 
$
11,378

 
$

 
$
(11,641
)
 
$

 
$

 
$
543

 
$
280

Equity method investments in proprietary fund products
 
12,167

 

 

 

 

 
73

 
12,240

Investments in partnerships, LLCs and other
 
22,167

 

 

 
(215
)
 

 

 
21,952

Equity method investments in partnerships and LLCs
 
153,931

 
1,330

 
(1,657
)
 
(12,078
)
 

 
1,581

 
143,107

Other investments
 
282

 

 

 

 

 
972

 
1,254

 
 
$
199,925

 
$
1,330

 
$
(13,298
)
 
$
(12,293
)
 
$

 
$
3,169

 
$
178,833


Realized and unrealized gains and losses recorded for Level 3 investments are included in Other income (expense) on the Consolidated Statements of Income. Total unrealized gains for Level 3 investments relating only to those assets still held at the reporting date were $1,284 and $1,068, respectively.

There were no material transfers between Level 1 and Level 2 during the three months ended June 30, 2012 and 2011.

12



As a practical expedient, Legg Mason relies on the NAV of certain investments as their fair value.  The NAVs that have been provided by the investees have been derived from the fair values of the underlying investments as of the reporting date.  The following table summarizes, as of June 30, 2012, the nature of these investments and any related liquidation restrictions or other factors which may impact the ultimate value realized:
 
 
 
 
Fair Value Determined Using NAV
 
As of June 30, 2012
Category of Investment
 
Investment Strategy
 
June 30, 2012
 
March 31, 2012
 
Unfunded Commitments
 
Remaining Term
Funds-of-hedge funds
 
Global macro, fixed income, long/short equity, natural resources, systematic, emerging market, European hedge
 
$
44,878

(1)
$
51,251

(2)
n/a

 
n/a
Hedge funds
 
Fixed income - developed market, event driven, fixed income - hedge, relative value arbitrage, European hedge
 
26,367

 
25,460

 
$
20,000

 
n/a
Private equity funds
 
Long/short equity
 
27,664

(3)
27,927

(3)
5,932

 
Up to 8 years
Private fund (4)
 
Fixed income, residential and commercial mortgage-backed securities
 
89,003

(3)
89,323

(3)
n/a

 
6 years, subject to two one-year extensions
Other
 
Various
 
2,153

 
2,450

 
n/a

 
Various (5)
Total
 
 
 
$
190,065

(6)
$
196,411

(6)
$
25,932

 
 
n/a-not applicable
(1)
59% monthly redemption; 41% quarterly redemption, of which 37% is subject to two-year lock-up.
(2)
63% monthly redemption; 37% quarterly redemption, of which 36% is subject to two-year lock-up.
(3)    Liquidations are expected over the remaining term.
(4)    Redemptions prohibited until November 2012.
(5)
4% remaining term of less than one year and 96% 20-year remaining term.
(6)
Comprised of approximately 13% and 87% of Level 2 and Level 3 assets, respectively, as of both June 30, 2012 and March 31, 2012.

There are no current plans to sell any of these investments held as of June 30, 2012.

4. Fixed Assets

Fixed assets consist of equipment, software and leasehold improvements.  Equipment consists primarily of communications and technology hardware and furniture and fixtures.  Software includes purchased software and internally developed software. Fixed assets are reported at cost, net of accumulated depreciation and amortization.  The following table reflects the components of fixed assets as of:

 
 
June 30, 2012
 
March 31, 2012
Equipment
 
$
154,294

 
$
155,173

Software
 
210,094

 
205,760

Leasehold improvements
 
243,565

 
242,566

Total cost
 
607,953

 
603,499

Less: accumulated depreciation and amortization
 
(375,552
)
 
(364,088
)
Fixed assets, net
 
$
232,401

 
$
239,411


Depreciation and amortization expense included in operating income was $13,575 and $17,301 for the three months ended June 30, 2012 and 2011, respectively.

 

13



5. Intangible Assets and Goodwill

The following table reflects the components of intangible assets as of:
 
 
June 30, 2012
 
March 31, 2012
Amortizable asset management contracts
 
 

 
 

Cost
 
$
205,486

 
$
206,411

Accumulated amortization
 
(175,554
)
 
(172,974
)
Net
 
29,932

 
33,437

Indefinite–life intangible assets
 
 

 
 

Fund management contracts
 
3,753,501

 
3,753,629

Trade names
 
69,800

 
69,800

 
 
3,823,301

 
3,823,429

Intangible assets, net
 
$
3,853,233

 
$
3,856,866


As of June 30, 2012, amortizable asset management contracts are being amortized over a weighted-average remaining life of 2.8 years.

Estimated amortization expense for each of the next five fiscal years is as follows:
Remaining 2013
 
$
10,514

2014
 
11,835

2015
 
2,920

2016
 
2,663

2017
 
2,000

Thereafter
 

Total
 
$
29,932


Indefinite-life fund management contracts include $2,502,000 of mutual fund contracts acquired in the Citigroup Asset Management ("CAM") acquisition, principally managed by ClearBridge Advisors LLC and Western Asset Management Company, which as of Legg Mason's most recent annual impairment test as of December 31, 2011, had an assessed fair value that exceeded its carrying value by 5%. Given the current uncertainty regarding future market conditions, should market performance, flows, or related AUM levels decrease in the near term such that cash flow projections deviate from current projections, it is reasonably possible that the asset could be deemed to be impaired by a material amount.

The change in the carrying value of goodwill is summarized below:
 
 
Gross Book Value
 
Accumulated Impairment
 
Net Book Value
Balance as of March 31, 2012
 
$
2,436,945

 
$
(1,161,900
)
 
$
1,275,045

Impact of excess tax basis amortization
 
(5,396
)
 

 
(5,396
)
Other, including changes in foreign exchange rates
 
(10,606
)
 

 
(10,606
)
Balance as of June 30, 2012
 
$
2,420,943

 
$
(1,161,900
)
 
$
1,259,043





14



6. Short-Term Borrowings and Long-Term Debt

The disclosures below include details of Legg Mason’s debt, excluding the debt of CIVs.  See Note 12, Variable Interest Entities and Consolidation of Investment Vehicles, for information related to the debt of CIVs.

In May 2012, Legg Mason announced a new capital plan that included the refinancing of its 2.5% Convertible Senior Notes (the "Notes”) due 2015, as further discussed below. The refinancing was effected through the issuance of $650,000 of 5.5% senior notes, the net proceeds of which, together with cash on hand and $250,000 of remaining borrowing capacity under an existing revolving credit facility, were used to repurchase the entire $1,250,000 face amount of the Notes.

Also, pursuant to the new capital plan, in June 2012, Legg Mason entered into a new unsecured credit agreement which provides for a new undrawn $500,000 revolving credit facility and a $500,000 term loan, also further discussed below. The proceeds of the term loan were used to repay the $500,000 of outstanding borrowings under the previous revolving credit facility, which was then terminated. As of March 31, 2012, there was $250,000 outstanding under the previous revolving credit facility, which had a then effective interest rate of 2.9%.
The new $500,000 revolving credit facility may be increased by an aggregate amount up to $250,000, subject to the approval of the lenders, and expires in June 2017. The new revolving credit facility has an interest rate of LIBOR plus 150 basis points and an annual commitment fee of 20 basis points. The interest rate may change in the future based on changes in Legg Mason's credit ratings. This revolving credit facility is available to fund working capital needs and for general corporate purposes. There were no borrowings outstanding under this facility as of June 30, 2012.
The revolving credit facility and term loan have standard financial covenants, including a maximum net debt to EBITDA ratio (as defined in the documents) of 2.5 to 1 and minimum EBITDA to interest ratio (as defined in the documents) of 4.0 to 1. As of June 30, 2012, Legg Mason's net debt to EBITDA ratio was 1.5 to 1 and EBITDA to interest expense ratio was 13.2 to 1, and therefore, Legg Mason has maintained compliance with the applicable covenants.
Five-year Term Loan
The $500,000 term loan entered into in conjunction with the unsecured credit agreement noted above can be repaid at any time and will be due in four annual installments of $50,000, beginning in June 2013, with the remainder to be repaid at maturity in June 2017. The term loan bears interest at LIBOR plus 150 basis points, which may change in the future based on changes in Legg Mason's credit ratings. The effective interest rate as of June 30, 2012 was 2.0%.
5.5% Senior Notes
The $650,000 5.5% Senior Notes (the "Senior Notes") due May 2019, were sold at a discount of $6,754, which is being amortized to interest expense over the seven-year term. The Senior Notes are subject to certain nonfinancial covenants and registration rights, which if not complied with, could require additional interest up to 0.50% over the stated rate. The Senior Notes can be redeemed at any time prior to their scheduled maturity, in part or in aggregate, at the greater of the related principal amount at that time or the sum of the remaining scheduled payments discounted at the Treasury rate (as defined) plus 0.50%, together with any related accrued and unpaid interest.
2.5% Convertible Senior Notes and Related Hedge Transactions
The terms of the repurchase of the Notes in May 2012 noted above included their repayment at par plus accrued interest, a prepayment fee of $6,250, and a non-cash exchange of warrants (the “Warrants”) to the holders of the Notes that replicate and extend the contingent conversion feature of the Notes. The cash payment of $1,256,250 to repurchase the Notes was allocated between their liability and equity components based on a liability fair value of $1,193,971, determined using a current market interest rate of 4.1%, resulting in a loss on debt extinguishment of $68,975, including $7,851 of accelerated deferred issue costs. The remaining balance of the cash payment was allocated to the equity component of the Notes for a $62,279 reduction of additional paid-in capital, offset by related tax benefits of $31,446. The $1,193,971 amount of cash repurchase payment allocated to the liability component of the Notes upon their extinguishment exceeds the initial allocated value at issuance of $977,933, requiring the Consolidated Statements of Cash Flows for the three months ended June 30, 2012 to include an allocation of the $216,038 excess to operating activities.
The Warrants issued to the holders of the Notes in connection with the repurchase of the Notes provide for the purchase, in the aggregate and subject to adjustment, of 14,205 shares of Legg Mason common stock, on a net share settled basis, at an

15



exercise price of $88 per share. Upon exercise of the Warrants, Legg Mason will be required to deliver to the holders of the Warrants, at its election, either shares of its common stock or cash, in an amount based on the excess of the market price per share of its common stock over the exercise price of the Warrants. The Warrants expire in July 2017. At execution of the repurchase, Legg Mason had the ability to settle its obligations under the Warrants with Legg Mason common stock. Accordingly, the Warrants were accounted for as equity.
In connection with the extinguishment of the Notes, the hedge transactions (purchased call options and warrants) executed in connection with the initial issuance of the Notes were also terminated.
The accreted value of long-term debt consists of the following:
 
 
June 30, 2012
 
March 31, 2012
 
 
Current Accreted Value
 
Unamortized Discount
 
Maturity Amount
 
Accreted Value
2.5% convertible senior notes
 
$

 
$

 
$

 
$
1,127,009

Five-year term loan
 
500,000

 

 
500,000

 

5.5% senior notes
 
643,348

 
6,652

 
650,000

 

Other term loans
 
9,453

 

 
9,453

 
9,883

Subtotal
 
1,152,801

 
6,652

 
1,159,453

 
1,136,892

Less: current portion
 
51,066

 

 
51,066

 
1,278

Total
 
$
1,101,735

 
$
6,652

 
$
1,108,387

 
$
1,135,614


As of June 30, 2012, the aggregate maturities of long-term debt, based on their contractual terms, are as follows:
Remaining 2013
 
$
853

2014
 
51,332

2015
 
51,386

2016
 
55,882

2017
 
50,000

Thereafter
 
950,000

Total
 
$
1,159,453


At June 30, 2012, the estimated fair value of long-term debt was $1,166,790, and is classified as Level 2 in the fair value hierarchy.

Prior to the repurchase of the Notes, as previously discussed, Legg Mason was accreting the carrying value of the Notes to the principal amount at maturity using an interest rate of 6.5% (the effective borrowing rate for non-convertible debt at the time of issuance) over its expected life of seven years, resulting in interest expense of $5,839 and $9,489 for the three months ended June 30, 2012 and 2011, respectively.

7.  Stock-Based Compensation

Legg Mason's stock-based compensation includes stock options, employee stock purchase plans, restricted stock awards and units, performance shares payable in common stock, and deferred compensation payable in stock. Effective July 26, 2011, the number of shares authorized to be issued under Legg Mason's active equity incentive stock plan was increased by 6,500 to 41,500. Shares available for issuance under the active equity incentive stock plan as of June 30, 2012, were 10,615. Options under Legg Mason’s employee stock plans have been granted at prices not less than 100% of the fair market value. Options are generally exercisable in equal increments over four to five years and expire within eight to ten years from the date of grant.
 
Compensation expense relating to stock options for the three months ended June 30, 2012 and 2011, was $3,283 and $4,181, respectively.


16



Stock option transactions during the three months ended June 30, 2012, and 2011, respectively, are summarized below:
 
 
Three Months Ended June 30,
 
 
2012
 
2011
 
 
Number of shares
 
Weighted-average exercise price per share
 
Number of shares
 
Weighted-average exercise price per share
Options outstanding at March 31
 
5,624

 
$
57.78

 
5,419

 
$
59.82

Granted
 
966

 
23.72

 
810

 
33.99

Exercised
 

 

 
(6
)
 
29.73

Canceled/forfeited
 
(263
)
 
65.61

 
(54
)
 
48.18

Options outstanding at June 30
 
6,327

 
$
52.25

 
6,169

 
$
56.56


At June 30, 2012, options were exercisable on 3,412 shares, with a weighted-average exercise price of $70.23 and a weighted-average remaining contractual life of 3.0 years. Unamortized compensation cost related to unvested options (2,915 shares) at June 30, 2012, was $28,368 and is expected to be recognized over a weighted-average period of 1.9 years.

The weighted-average fair value of stock option grants during the three months ended June 30, 2012 and 2011, using the Black‑Scholes option pricing model, was $9.47 and $13.13 per share, respectively.

The following weighted-average assumptions were used in the model for grants in fiscal 2013 and 2012:
 
 
Three Months Ended June 30,
 
 
2012
 
2011
Expected dividend yield
 
1.44
%
 
1.39
%
Risk-free interest rate
 
0.81
%
 
1.95
%
Expected volatility
 
51.80
%
 
47.16
%
Expected life (in years)
 
5.02

 
5.12


Compensation expense relating to restricted stock and restricted stock units for the three months ended June 30, 2012 and 2011, was $9,307 and $8,075, respectively.

Restricted stock and restricted stock unit transactions during the three months ended June 30, 2012 and 2011, respectively, are summarized below:
 
 
Three Months Ended June 30,
 
 
2012
 
2011
 
 
Number of shares
 
Weighted-average grant date value
 
Number of shares
 
Weighted-average grant date value
Unvested shares at March 31
 
2,873

 
$
33.83

 
2,637

 
$
33.01

Granted
 
1,842

 
23.72

 
1,247

 
33.99

Vested
 
(881
)
 
32.41

 
(678
)
 
34.05

Canceled/forfeited
 
(27
)
 
30.86

 
(19
)
 
33.29

Unvested shares at June 30
 
3,807

 
$
29.29

 
3,187

 
$
33.17


Unamortized compensation cost related to unvested restricted stock and restricted stock unit awards at June 30, 2012 of $96,936 is expected to be recognized over a weighted-average period of 1.9 years.

Compensation expense relating to the stock purchase plan and deferred compensation payable in stock for the three months ended June 30, 2012 and 2011, was $144 and $175, respectively.

As of June 30, 2012 and 2011, non-employee directors held 184 and 220 stock options, respectively, which are included in

17



the outstanding options presented in the table above. As of June 30, 2012 and 2011, non-employee directors held 74 and 62 restricted stock units, respectively, which vest on the grant date and are, therefore, not included in the unvested shares of restricted stock and restricted stock units in the table above. There were no stock option, restricted stock or restricted stock unit transactions related to non-employee directors during the three months ended June 30, 2012 and 2011.

During fiscal 2012, Legg Mason established a long-term incentive plan (the "LTIP") under its equity incentive plan, which provides an additional element of compensation that is based on performance. Under the LTIP, executive officers were granted cash value performance units in the June 2011 quarter that will vest at the end of a three year period based upon Legg Mason's cumulative adjusted earnings per share over the period. Awards granted under the LTIP may be settled in cash and/or shares of Legg Mason common stock, at the discretion of Legg Mason. The estimated payout amount of the award, if any, would be expensed over the vesting period based on a probability assessment of the expected outcome under the LTIP provisions.

As part of the Company's streamlining initiative, as further discussed in Note 11, the employment of certain recipients of stock option and restricted stock awards has been terminated. The termination benefits extended to these employees included accelerated vesting of their unvested equity incentive awards to January 1, 2012, which precedes dates under the original terms of the awards.

8. Commitments and Contingencies

Legg Mason leases office facilities and equipment under non-cancelable operating leases, and also has multi-year agreements for certain services. These leases and service agreements expire on varying dates through fiscal 2026. Certain leases provide for renewal options and contain escalation clauses providing for increased rentals based upon maintenance, utility and tax increases.
 
As of June 30, 2012, the minimum annual aggregate rentals under operating leases and service agreements are as follows:
Remaining 2013
 
$
110,944

2014
 
120,285

2015
 
110,754

2016
 
99,309

2017
 
90,305

Thereafter
 
503,819

Total
 
$
1,035,416


The minimum rental commitments shown above have not been reduced by $144,740 for minimum sublease rentals to be received in the future under non-cancelable subleases, of which approximately 51% is due from one counterparty.  If a sub-tenant defaults on a sublease, Legg Mason may incur operating charges to reflect expected future sublease rentals at reduced amounts, as a result of the current commercial real estate market.

The above minimum rental commitments include $931,459 in real estate and equipment leases and $103,957 in service and maintenance agreements.

As of June 30, 2012, Legg Mason had commitments to invest approximately $36,673 in limited partnerships that make private investments. These commitments are expected to be funded as required through the end of the respective investment periods ranging through fiscal 2018.

In the normal course of business, Legg Mason enters into contracts that contain a variety of representations and warranties and that provide general indemnifications, which are not considered financial guarantees by relevant accounting guidance. Legg Mason’s maximum exposure under these arrangements is unknown, as this would involve future claims that may be made against Legg Mason that have not yet occurred.

Legg Mason has been the subject of customer complaints and has also been named as a defendant in various legal actions arising primarily from securities brokerage, asset management and investment banking activities, including certain class actions, which primarily allege violations of securities laws and seek unspecified damages, which could be substantial. In

18



the normal course of its business, Legg Mason has also received subpoenas and is currently involved in governmental and self-regulatory agency inquiries, investigations and, from time to time, proceedings involving asset management activities. In accordance with guidance for accounting for contingencies, Legg Mason has established provisions for estimated losses from pending complaints, legal actions, investigations and proceedings when it is probable that a loss has been incurred and a reasonable estimate of loss can be made.

In a transaction with Citigroup in December 2005, Legg Mason transferred to Citigroup the subsidiaries that constituted its Private Client/Capital Markets ("PC/CM") businesses, thus transferring the entities that would have primary liability for most of the customer complaint, litigation and regulatory liabilities and proceedings arising from those businesses. However, as part of that transaction, Legg Mason agreed to indemnify Citigroup for most customer complaint, litigation and regulatory liabilities of Legg Mason's former PC/CM businesses that result from pre-closing events. While the ultimate resolution of these matters cannot be currently determined based on current information, after consultation with legal counsel, management believes that any accrual or range of reasonably possible losses as of June 30, 2012 and 2011, is not material. Similarly, although Citigroup transferred to Legg Mason the entities that would be primarily liable for most customer complaint, litigation and regulatory liabilities and proceedings of the CAM business, Citigroup has agreed to indemnify Legg Mason for most customer complaint, litigation and regulatory liabilities of the CAM business that result from pre-closing events.

One of Legg Mason's asset management subsidiaries was named as the defendant in a lawsuit filed by a former institutional client in late August 2011. The complaint alleges breach of contract and breach of fiduciary duty arising from investments in the former client's account allegedly being inconsistent with the account's objectives, and seeks damages in excess of $90,000. Legg Mason believes that the claims are without merit and intends to defend the matter vigorously. Discovery in the case is ongoing, and a pretrial conference is currently scheduled for April 2013. Because of the preliminary status of the matter, Legg Mason cannot estimate the possible loss or range of loss from this matter, if any. In addition, although Legg Mason believes that this matter would likely be covered by insurance policies that may substantially mitigate the amount of any eventual loss, as is not unusual with litigation at this point in the process, there can be no assurance that the action will not have a material effect on Legg Mason's financial position, results of operations or cash flows.

The ultimate resolution of other matters, described above as customer complaints, legal actions, inquiries, proceedings and investigations, cannot be currently determined. In the opinion of management and after consultation with legal counsel, due to the preliminary nature of these matters, Legg Mason is currently unable to estimate the amount or range of reasonably possible losses from these matters, and Legg Mason's financial condition, results of operations and cash flows could be materially affected during a period in which a matter is ultimately resolved. In addition, the ultimate costs of litigation-related charges can vary significantly from period-to-period, depending on factors such as market conditions, the size and volume of customer complaints and claims, including class action suits, and recoveries from indemnification, contribution or insurance reimbursement.

9. Earnings Per Share

Basic earnings per share ("EPS") is calculated by dividing Net Income (Loss) Attributable to Legg Mason, Inc. by the weighted-average number of shares outstanding. The calculation of weighted-average shares includes common shares, shares exchangeable into common stock and unvested restricted shares deemed to be participating securities. Diluted EPS is similar to basic EPS, but adjusts for the effect of potentially issuable common shares, except when inclusion is antidilutive. For periods where a net loss attributable to Legg Mason, Inc. is reported, the inclusion of potentially issuable common shares will decrease the net loss per share. Since this would be antidilutive, such shares are excluded from the calculation.

In May 2012, as part of a new capital plan, Legg Mason's Board of Directors authorized $1,000,000 for additional purchases of Legg Mason common stock, as well as the acceleration of the repurchase of the remaining approximate $155,000 of Legg Mason common stock previously authorized. The new capital plan authorizes using up to 65% of cash generated from future operations, beginning in fiscal 2013, to purchase shares of Legg Mason common stock.

During the three months ended June 30, 2012, Legg Mason purchased and retired 6,173 shares of its common stock for $155,000 through open market purchases, which completes the repurchase of its common stock under the previous authorization. These repurchases reduced weighted-average shares outstanding by 2,158 shares for the three months ended June 30, 2012.

During the three months ended June 30, 2012 and 2011, Legg Mason issued 1,842 and 1,248 shares, respectively, of restricted

19



stock related to its annual incentive awards, of which 931 and 631 shares are included in weighted-average shares outstanding for the three months ended June 30, 2012 and 2011, respectively.

In June 2011, Legg Mason issued 1,830 shares of common stock upon the exercise of purchase contracts on the remaining Equity Units issued in May 2008. As the exercise occurred on June 30, 2011, the number of shares included in weighted-average shares outstanding is immaterial for the three months ended June 30, 2011.

The following table presents the computations of basic and diluted EPS:
 
 
Three Months Ended June 30,
 
 
2012
 
2011
 
 
Basic
 
Diluted (1)
 
Basic
 
Diluted
Weighted-average basic shares outstanding
 
138,720

 
138,720

 
149,210

 
149,210

Potential common shares:
 
 
 
 
 
 
 
 
Employee stock options
 

 

 

 
137

Weighted-average diluted shares
 
138,720

 
138,720

 
149,210

 
149,347

Net Income (Loss)
 
$
(12,984
)
 
$
(12,984
)
 
$
61,698

 
$
61,698

Less: Net income (loss) attributable to noncontrolling interests
 
(3,526
)
 
(3,526
)
 
1,746

 
1,746

Net Income (Loss) Attributable to Legg Mason, Inc.
 
$
(9,458
)
 
$
(9,458
)
 
$
59,952

 
$
59,952

Net Income (Loss) per Share Attributable to Legg Mason, Inc. Common Shareholders

 
$
(0.07
)
 
$
(0.07
)
 
$
0.40

 
$
0.40

(1) Diluted shares are the same as basic shares for periods with a net loss.

The diluted EPS calculation for the three months ended June 30, 2012, excludes 5,823 potential common shares that are antidilutive due to the net loss for the period. Further, for the three months ended June 30, 2012, the 14,205 of Warrants issued in connection with the repurchase of the Notes, as discussed in Note 6, would be excluded from the calculation of dilutive EPS because the market price of Legg Mason common stock did not exceed the exercise price, and therefore the Warrants would be deemed antidilutive.

The diluted EPS calculation for the three months ended June 30, 2011, excludes any potential common shares issuable under the Notes, because the market price of Legg Mason common stock had not exceeded the price at which conversion would be dilutive using the treasury stock method. Also, for the three months ended June 30, 2011, warrants issued in connection with the convertible note hedge transactions associated with the issuance of the 2.5% Convertible Senior Notes are excluded from the calculation of diluted earnings per share because the effect would be antidilutive.

Options to purchase 4,659 shares for the three months ended June 30, 2011, were not included in the computation of diluted earnings per share because the presumed proceeds from exercising such options, including related income tax benefits, exceed the average price of the common shares for the period and therefore the options are deemed antidilutive.

10. Derivatives and Hedging

The disclosures below detail Legg Mason’s derivatives and hedging excluding the derivatives and hedging of CIVs. See Note 12, Variable Interest Entities and Consolidation of Investment Vehicles, for information related to the derivatives and hedging of CIVs.

Legg Mason uses currency forwards to economically hedge the risk of movements in exchange rates, primarily between the U.S. dollar, euro, Japanese yen, Singapore dollar, Brazilian real, and British pound. In the Consolidated Balance Sheets, Legg Mason nets the fair value of certain foreign currency forwards executed with the same counterparty where Legg Mason has both the legal right and intent to settle the contracts on a net basis. Legg Mason has not designated any derivatives as hedging instruments during the periods ended June 30, 2012, March 31, 2012 and June 30, 2011.

Legg Mason also uses market hedges on certain seed capital investments by entering into futures contracts to sell index funds that benchmark the hedged seed capital investments. Open futures contracts required cash collateral of $2,327 and $1,919 as of June 30, 2012 and March 31, 2012, respectively.  

20




The following table presents the fair values as of June 30, 2012 and March 31, 2012, of derivative instruments not designated as hedging instruments for accounting purposes, classified as Other assets and Other liabilities:

 
 
June 30, 2012
 
March 31, 2012
 
 
Assets
 
Liabilities
 
Assets
 
Liabilities
Currency forward contracts
 
$
1,125

 
$
276

 
$
38

 
$
685

Futures contracts
 
4

 
486

 
46

 
201

Total
 
$
1,129

 
$
762

 
$
84

 
$
886


The following table presents gains (losses) recognized on derivative instruments for the three months ended June 30, 2012 and 2011:
 
 
 
 
Three months ended June 30,
 
 
 
 
2012
 
2011
 
 
Income Statement Classification
 
Gains
 
Losses
 
Gains
 
Losses
Currency forward contracts for:
 
 
 
 
 
 
 
 
 
 
Operating activities
 
Other expense
 
$
1,400

 
$
(373
)
 
$
1,986

 
$
(2,860
)
Seed capital investments
 
Other non-operating income (expense)
 
287

 
(30
)
 
30

 
(158
)
Futures contracts
 
Other non-operating income (expense)
 
1,014

 
(541
)
 
1,661

 
(1,494
)
Total
 
 
 
$
2,701

 
$
(944
)
 
$
3,677

 
$
(4,512
)

11. Restructuring

In May 2010, Legg Mason announced a plan to streamline its business model to drive increased profitability and growth that primarily involved transitioning certain shared services to its investment affiliates which are closer to actual client relationships.  This plan involved headcount reductions in operations, technology, and other administrative areas, which were partially offset by headcount increases at the affiliates, and enabled Legg Mason to eliminate a portion of its corporate office space that was primarily dedicated to operations and technology employees.  The initiative was complete as of March 31, 2012.

Total transition-related costs were $127,500, including non-cash charges of $30,841, through completion of the plan in March 2012. Of the total transition-related costs incurred, $79,686 were related to charges for employee termination benefits and retention incentives during the transition period, and were recorded in Transition-related compensation in the Consolidated Statements of Income (Loss). The remainder represents other costs, including charges for consolidating leased office space, early contract terminations, asset disposals, and professional fees, which were recorded in the appropriate operating expense classifications. Charges for transition-related costs were $13,720 for the three months ended June 30, 2011, which primarily represent costs for severance and retention incentives.


21



The table below presents a summary of changes in the transition-related liability from March 31, 2011 through June 30, 2012:
 
 
Severance and retention incentives
 
Lease loss accruals and other
 
Total
Balance as of March 31, 2011
 
$
23,211

 
$
5,835

 
$
29,046

Accrued charges
 
29,096

 
25,916

(1
)
55,012

Payments
 
(51,140
)
 
(16,121
)
 
(67,261
)
Balance as of March 31, 2012
 
1,167

 
15,630

 
16,797

Payments and other
 
(967
)
(2
)
(1,502
)
 
(2,469
)
Balance as of June 30, 2012
 
$
200

 
$
14,128

 
$
14,328

(1)
Includes lease loss accruals of $17,983 for space permanently abandoned.
(2)
Includes immaterial adjustments to the transition-related liability.


12. Variable Interest Entities and Consolidation of Investment Vehicles

In the normal course of its business, Legg Mason sponsors and is the manager of various types of investment vehicles. Certain of these investment vehicles are considered to be variable interest entities (“VIEs”) while others are considered to be voting rights entities (“VREs”) subject to traditional consolidation concepts based on ownership rights. For its services, Legg Mason is entitled to receive management fees and may be eligible, under certain circumstances, to receive additional subordinate management fees or other incentive fees. Legg Mason's exposure to risk in these entities is generally limited to any equity investment it has made or is required to make and any earned but uncollected management fees. Investment vehicles that are considered VREs are consolidated if Legg Mason has a controlling financial interest in the investment vehicle, absent substantive kick-out rights.

Financial Accounting Standards Board Interpretation No. 46(R) (Accounting Standards Update 2010-10, "Amendments to Statement 167 for Certain Investment Funds")
For most sponsored investment funds, including money market funds, Legg Mason determines it is the primary beneficiary of a VIE if it absorbs a majority of the VIE's expected losses, or receives a majority of the VIE's expected residual returns, if any. Legg Mason's determination of expected residual returns excludes gross fees paid to a decision maker if certain criteria are met. In determining whether it is the primary beneficiary of a VIE, Legg Mason considers both qualitative and quantitative factors such as the voting rights of the equity holders, economic participation of all parties, including how fees are earned and paid to Legg Mason, related party ownership, guarantees and implied relationships.
Legg Mason concluded it was the primary beneficiary of one sponsored investment fund VIE, and also held a controlling financial interest in one sponsored investment fund VRE, both of which were consolidated as of June 30, 2012, March 31, 2012 and June 30, 2011. Effective December 31, 2011, a controlling financial interest of $20,814 in a second sponsored investment fund VRE previously consolidated by Legg Mason was redeemed. Accordingly, the fund was deconsolidated by Legg Mason and the fund's balance sheet amounts have been excluded from Legg Mason's consolidated balance sheet as of March 31, 2012, but income statement and cash flow amounts for the fund have been included in Legg Mason's consolidated income and cash flow statements for the three months ended June 30, 2011.
Statement of Financial Accounting Standards No. 167 (Accounting Standards Codification Topic 810, "Consolidation")
For other sponsored investment funds that do not meet certain criteria, if Legg Mason has a significant variable interest, it determines it is the primary beneficiary of the VIE if it has both the power to direct the activities of the VIE that most significantly impact the entity's economic performance and the obligation to absorb losses, or the right to receive benefits, that potentially could be significant to the VIE.
Legg Mason concluded that it was the primary beneficiary of one of two CLOs in which it has a variable interest. Although it holds no equity interest in either of these investment vehicles, it had both the power to control and had a significant variable interest in one CLO because of the level of its expected subordinated fees. As of June 30, 2012, March 31, 2012 and June 30, 2011, the balances related to this CLO were consolidated on the Company's consolidated financial statements. The other CLO is not consolidated as its level of expected subordinated fees is insignificant.

22



Legg Mason's investment in CIVs as of June 30, 2012 and March 31, 2012, was $37,164 and $38,919, respectively, which represents its maximum risk of loss, excluding uncollected advisory fees. The assets of these CIVs are primarily comprised of investment securities. Investors and creditors of these CIVs have no recourse to the general credit or assets of Legg Mason beyond its investment in these funds.

The following tables reflect the impact of CIVs on the Consolidated Balance Sheets as of June 30, 2012 and March 31, 2012, respectively, and the Consolidated Statements of Income for the three months ended June 30, 2012 and 2011, respectively:
Consolidating Balance Sheets
 
 
June 30, 2012
 
March 31, 2012
 
 
Balance
Before
Consolidation of CIVs
 
CIVs
 
Eliminations
 
As Reported
 
Balance
Before
Consolidation of CIVs
 
CIVs
 
Eliminations
 
As Reported
Current assets
 
$
1,658,681

 
$
57,902

 
$
(37,577
)
 
$
1,679,006

 
$
2,439,162

 
$
57,714

 
$
(39,408
)
 
$
2,457,468

Non-current assets
 
5,821,363

 
298,638

 

 
6,120,001

 
5,801,680

 
296,599

 

 
6,098,279

Total assets
 
$
7,480,044

 
$
356,540

 
$
(37,577
)
 
$
7,799,007

 
$
8,240,842

 
$
354,313

 
$
(39,408
)
 
$
8,555,747

Current liabilities
 
$
495,045

 
$
12,582

 
$
(413
)
 
$
507,214

 
$
971,804

 
$
4,467

 
$
(489
)
 
$
975,782

Long-term debt of CIVs
 

 
273,560

 

 
273,560

 

 
271,707

 

 
271,707

Other non-current liabilities
 
1,536,721

 
3,620

 

 
1,540,341

 
1,603,064

 
3,872

 

 
1,606,936

Total liabilities
 
2,031,766

 
289,762

 
(413
)
 
2,321,115

 
2,574,868

 
280,046

 
(489
)
 
2,854,425