LM_10Q_9.30.2012


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 September 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.
131,713,033 shares of common stock as of the close of business on November 1, 2012.




PART I. FINANCIAL INFORMATION
Item 1.         Financial Statements

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

 
 
September 30, 2012
 
March 31, 2012
ASSETS
 
 
 
 
Current Assets
 
 
 
 
Cash and cash equivalents
 
$
897,968

 
$
1,382,263

Cash and cash equivalents of consolidated investment vehicles
 
28,704

 
26,139

Restricted cash
 
2,564

 
2,167

Receivables:
 
 
 
 
Investment advisory and related fees
 
325,228

 
333,777

Other
 
35,835

 
100,060

Investment securities
 
354,355

 
412,119

Investment securities of consolidated investment vehicles
 
29,512

 
31,575

Deferred income taxes
 
111,163

 
117,391

Other
 
45,931

 
51,977

Total current assets
 
1,831,260

 
2,457,468

Fixed assets, net
 
229,982

 
239,411

Intangible assets, net
 
3,849,916

 
3,856,866

Goodwill
 
1,256,146

 
1,275,045

Investments of consolidated investment vehicles
 
288,132

 
294,853

Deferred income taxes
 
168,319

 
142,706

Other
 
249,396

 
287,653

Other assets of consolidated investment vehicles
 
1,748

 
1,745

Total Assets
 
$
7,874,899

 
$
8,555,747

 
 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
 

Liabilities
 
 

 
 

Current Liabilities
 
 

 
 

Accrued compensation
 
$
282,923

 
$
409,759

Accounts payable and accrued expenses
 
193,416

 
195,808

Short-term borrowings
 

 
250,000

Current portion of long-term debt
 
58,372

 
1,278

Other
 
63,919

 
114,840

Other current liabilities of consolidated investment vehicles
 
684

 
4,097

Total current liabilities
 
599,314

 
975,782

Deferred compensation
 
44,756

 
57,339

Deferred income taxes
 
211,395

 
242,567

Other
 
166,095

 
167,544

Other liabilities of consolidated investment vehicles
 
3,514

 
3,872

Long-term debt
 
1,094,467

 
1,135,614

Long-term debt of consolidated investment vehicles
 
277,309

 
271,707

Total Liabilities
 
2,396,850

 
2,854,425

 
 
 
 
 
Commitments and Contingencies (Note 8)
 


 


 
 
 
 
 
Redeemable Noncontrolling Interests
 
21,549

 
24,031

 
 
 
 
 
Stockholders’ Equity
 
 
 
 
Common stock, par value $.10; authorized 500,000,000 shares; issued 131,707,918 shares and 139,874,034 shares, respectively
 
13,171

 
13,987

Additional paid-in capital
 
3,610,904

 
3,864,216

Employee stock trust
 
(33,245
)
 
(32,419
)
Deferred compensation employee stock trust
 
33,245

 
32,419

Retained earnings
 
1,757,184

 
1,715,395

Appropriated retained earnings for consolidated investment vehicle
 
9,175

 
12,221

Accumulated other comprehensive income, net
 
66,066

 
71,472

Total Stockholders’ Equity
 
5,456,500

 
5,677,291

Total Liabilities and Stockholders’ Equity
 
$
7,874,899

 
$
8,555,747

See Notes to Consolidated Financial Statements

2



LEGG MASON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME

(Dollars in thousands, except per share amounts)
(Unaudited)

 
 
Three Months Ended
 
Six Months Ended
 
 
September 30,
 
September 30,
 
 
2012
 
2011
 
2012
 
2011
Operating Revenues
 
 
 
 
 
 
 
 
Investment advisory fees:
 
 
 
 
 
 
 
 
Separate accounts
 
$
183,426

 
$
196,019

 
$
365,862

 
$
400,812

Funds
 
362,907

 
376,835

 
719,381

 
776,979

Performance fees
 
10,279

 
9,984

 
18,845

 
28,598

Distribution and service fees
 
81,915

 
85,774

 
163,538

 
177,838

Other
 
1,768

 
1,285

 
3,361

 
2,778

Total operating revenues
 
640,295

 
669,897

 
1,270,987

 
1,387,005

Operating Expenses
 


 
 
 


 


Compensation and benefits
 
302,492

 
257,651

 
572,754

 
558,003

Transition-related compensation
 

 
12,346

 

 
23,741

Total compensation and benefits
 
302,492

 
269,997

 
572,754

 
581,744

Distribution and servicing
 
145,135

 
160,391

 
314,960

 
341,147

Communications and technology
 
35,831

 
41,571

 
73,461

 
82,072

Occupancy
 
27,318

 
35,700

 
57,570

 
68,938

Amortization of intangible assets
 
3,504

 
5,504

 
7,009

 
11,082

Other
 
46,281

 
49,882

 
89,422

 
94,804

Total operating expenses
 
560,561

 
563,045

 
1,115,176

 
1,179,787

Operating Income
 
79,734

 
106,852

 
155,811

 
207,218

Other Non-Operating Income (Expense)
 


 
 
 


 


Interest income
 
1,718

 
2,982

 
3,654

 
6,037

Interest expense
 
(14,118
)
 
(21,636
)
 
(33,345
)
 
(43,997
)
Other income (expense), net, including $68,975 debt extinguishment loss in May 2012
 
28,655

 
(35,502
)
 
(43,978
)
 
(32,099
)
Other non-operating income (loss) of consolidated investment vehicles, net
 
1,503

 
3,081

 
(2,631
)
 
8,183

Total other non-operating income (expense)
 
17,758

 
(51,075
)
 
(76,300
)
 
(61,876
)
Income Before Income Tax Provision
 
97,492

 
55,777

 
79,511

 
145,342

Income tax provision (benefit)
 
16,397

 
(1,606
)
 
11,400

 
26,261

Net Income
 
81,095

 
57,383

 
68,111

 
119,081

Less: Net income (loss) attributable to noncontrolling interests
 
298

 
719

 
(3,228
)
 
2,465

Net Income Attributable to Legg Mason, Inc.
 
$
80,797

 
$
56,664

 
$
71,339

 
$
116,616

 
 
 
 
 
 
 
 
 
Net Income per Share Attributable to Legg Mason, Inc. Common Shareholders:
 
 
 
 
 
 
 
 
Basic
 
$
0.60

 
$
0.39

 
$
0.52

 
$
0.80

Diluted
 
$
0.60

 
$
0.39

 
$
0.52

 
$
0.80

 
 
 
 
 
 
 
 
 
Weighted Average Number of Shares Outstanding
 
 
 
 
 
 
 
 
Basic
 
134,098

 
143,877

 
136,396

 
146,529

Diluted
 
134,128

 
143,931

 
136,425

 
146,625

 
 
 
 
 
 
 
 
 
Dividends Declared per Share
 
$
0.11

 
$
0.08

 
$
0.22

 
$
0.16

See Notes to Consolidated Financial Statements

3



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



 
 
Three Months Ended
 
Six Months Ended
 
 
September 30,
 
September 30,
 
 
2012
 
2011
 
2012
 
2011
Net Income
 
$
81,095

 
$
57,383

 
$
68,111

 
$
119,081

Other comprehensive income:
 
 
 


 
 
 


Foreign currency translation adjustment
 
7,666

 
(46,026
)
 
(5,469
)
 
(32,666
)
Unrealized gains on investment securities:
 
 
 


 
 
 


Unrealized holding gains, net of tax provision of $2, $124, $43 and $172, respectively
 
3

 
186

 
65

 
253

Reclassification adjustment for (gains) losses included in net income
 
7

 

 
(2
)
 
4

Net unrealized gains on investment securities
 
10

 
186

 
63

 
257

Total other comprehensive income (loss)
 
7,676

 
(45,840
)
 
(5,406
)
 
(32,409
)
Comprehensive Income
 
88,771

 
11,543

 
62,705

 
86,672

Less: Comprehensive income (loss) attributable to noncontrolling interests
 
298

 
719

 
(3,228
)
 
2,465

Comprehensive Income Attributable to Legg Mason, Inc.
 
$
88,473

 
$
10,824

 
$
65,933

 
$
84,207

See Notes to Consolidated Financial Statements

4



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


 
 
Six Months Ended September 30,
 
 
2012
 
2011
COMMON STOCK
 
 
 
 
Beginning balance
 
$
13,987

 
$
15,022

Stock options and other stock-based compensation
 
6

 
7

Deferred compensation employee stock trust
 
5

 
4

Deferred compensation, net
 
175

 
120

Equity Units exchanged
 

 
183

Employee tax withholdings by net share transactions
 
(29
)
 

Shares repurchased and retired
 
(973
)
 
(1,360
)
Ending balance
 
13,171

 
13,976

ADDITIONAL PAID-IN CAPITAL
 
 

 
 

Beginning balance
 
3,864,216

 
4,111,095

Stock options and other stock-based compensation
 
7,173

 
9,800

Deferred compensation employee stock trust
 
1,232

 
1,477

Deferred compensation, net
 
20,846

 
16,487

Equity Units exchanged
 

 
102,831

Employee tax withholdings by net share transactions
 
(7,632
)
 

Shares repurchased and retired
 
(244,098
)
 
(398,906
)
Allocation from 2.5% Convertible Senior Notes repurchase, net of tax
 
(30,833
)
 

Ending balance
 
3,610,904

 
3,842,784

EMPLOYEE STOCK TRUST
 
 

 
 

Beginning balance
 
(32,419
)
 
(34,466
)
Shares issued to plans
 
(1,237
)
 
(1,481
)
Distributions and forfeitures
 
411

 
914

Ending balance
 
(33,245
)
 
(35,033
)
DEFERRED COMPENSATION EMPLOYEE STOCK TRUST
 
 

 
 

Beginning balance
 
32,419

 
34,466

Shares issued to plans
 
1,237

 
1,481

Distributions and forfeitures
 
(411
)
 
(914
)
Ending balance
 
33,245

 
35,033

RETAINED EARNINGS
 
 

 
 

Beginning balance
 
1,715,395

 
1,539,984

Net income attributable to Legg Mason, Inc.
 
71,339

 
116,616

Dividends declared
 
(29,550
)
 
(23,695
)
Ending balance
 
1,757,184

 
1,632,905

APPROPRIATED RETAINED EARNINGS FOR CONSOLIDATED INVESTMENT VEHICLE
 
 

 
 

Beginning balance
 
12,221

 
10,922

Net loss reclassified to appropriated retained earnings
 
(3,046
)
 
(5,802
)
Ending balance
 
9,175

 
5,120

ACCUMULATED OTHER COMPREHENSIVE INCOME, NET
 
 

 
 

Beginning balance
 
71,472

 
93,361

Net unrealized holding gains on investment securities
 
63

 
257

Foreign currency translation adjustment
 
(5,469
)
 
(32,666
)
Ending balance
 
66,066

 
60,952

TOTAL STOCKHOLDERS’ EQUITY
 
$
5,456,500

 
$
5,555,737


See Notes to Consolidated Financial Statements

5



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

September 30,
 

2012

2011
Cash Flows from Operating Activities
 
 
 
 
Net Income
 
$
68,111

 
$
119,081

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

Loss on extinguishment
 
68,975

 

Adjustments to reconcile Net Income to net cash provided by operations:
 
 
 
 
Depreciation and amortization
 
33,480

 
45,045

Imputed interest for 2.5% Convertible Senior Notes
 
5,839

 
19,230

Accretion and amortization of securities discounts and premiums, net
 
1,790

 
2,381

Stock-based compensation
 
27,160

 
25,948

Net (gains) losses on investments
 
(23,072
)
 
37,846

Net losses of consolidated investment vehicles
 
4,063

 
2,198

Deferred income taxes
 
(6,278
)
 
17,701

Other
 
2,387

 
901

Decrease (increase) in assets:
 
 
 
 
Investment advisory and related fees receivable
 
9,458

 
40,218

Net sales (purchases) of trading and other current investments
 
119,265

 
(44,822
)
Other receivables
 
7,927

 
(3,605
)
Other assets
 
6,030

 
14,419

Other assets of consolidated investment vehicles
 
666

 
22,479

Increase (decrease) in liabilities:
 
 
 
 
Accrued compensation
 
(126,576
)
 
(73,968
)
Deferred compensation
 
(12,583
)
 
(32,134
)
Accounts payable and accrued expenses
 
(2,348
)
 
(18,370
)
Other liabilities
 
(1,469
)
 
9,186

Other liabilities of consolidated investment vehicles
 
(3,666
)
 
(15,565
)
Cash Provided by (Used in) Operating Activities
 
(36,879
)
 
168,169

Cash Flows from Investing Activities
 
 

 
 

Payments for fixed assets
 
(18,316
)
 
(14,577
)
Change in restricted cash
 
(757
)
 
7,705

Purchases of investment securities
 
(4,406
)
 
(3,754
)
Proceeds from sales and maturities of investment securities
 
4,000

 
3,590

Purchases of investments by consolidated investment vehicles
 
(74,172
)
 
(113,668
)
Proceeds from sales and maturities of investments by consolidated investment vehicles
 
81,508

 
123,765

Cash Provided by (Used in) Investing Activities
 
$
(12,143
)
 
$
3,061


6



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

 
 
Six Months Ended
 

September 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
 
(634
)
 
(391
)
Proceeds from issuance of long-term debt
 
1,143,246

 

Debt issuance costs
 
(8,642
)
 

Issuance of common stock
 
1,014

 
1,453

Repurchase of common stock
 
(252,732
)
 
(400,266
)
Dividends paid
 
(26,251
)
 
(21,029
)
Net repayments of consolidated investment vehicles
 

 
(18,309
)
Net (redemptions/distributions paid to)/subscriptions received from noncontrolling interest holders
 
(2,300
)
 
649

Cash Used in Financing Activities
 
(436,511
)
 
(437,893
)
Effect of Exchange Rate Changes on Cash
 
1,238

 
(15,611
)
Net Decrease in Cash and Cash Equivalents
 
(484,295
)
 
(282,274
)
Cash and Cash Equivalents at Beginning of Period
 
1,382,263

 
1,375,918

Cash and Cash Equivalents at End of Period
 
$
897,968

 
$
1,093,644



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)
September 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 Legg Mason's 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 Legg Mason's 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 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, 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 completed 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. 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, the completion of the existing share repurchase authorization, and the authorization of further share repurchases. As a result, Net Income Attributable to Legg Mason, Inc. for the six months ended September 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
In July 2011, The U.K. Finance Act 2011 was enacted, which reduced the main U.K. corporate tax rate from 27% to 26% effective April 1, 2011, and from 26% to 25% effective April 1, 2012. In July 2012, The U.K. Finance Act 2012 was enacted, further reducing the main U.K. corporate tax rate to 24% effective April 1, 2012 and 23% effective April 1, 2013. The reductions in the U.K. corporate tax rate resulted in tax benefits of $18,075 and $18,268, recognized in the quarters ended September 30, 2012 and 2011, respectively, as a result of the revaluation of existing deferred tax assets and liabilities at the new rates. As a result of the revaluation adjustments, the effective tax rate for the three and six months ended September 30, 2012, was reduced by 18.5 percentage points and 22.7 percentage points, respectively. Similarly, the effective tax rate for the three and six months ended September 30, 2011, was reduced by 32.8 percentage points and 12.6 percentage points, respectively.

Noncontrolling Interests
Noncontrolling interests related to consolidated investment vehicles ("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 September 30, 2012, March 31, 2012, or September 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 and six months ended September 30, 2012 and 2011, included the following amounts:
 
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
 
2012
 
2011
 
2012
 
2011
Net income (loss) attributable to redeemable noncontrolling interests
 
$
479

 
$
4,376

 
$
(182
)
 
$
8,267

Net loss reclassified to Appropriated retained earnings for consolidated investment vehicle
 
(181
)
 
(3,657
)
 
(3,046
)
 
(5,802
)
Total
 
$
298

 
$
719

 
$
(3,228
)
 
$
2,465


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

 
$
36,712

Net income (loss) attributable to redeemable noncontrolling interests
 
(182
)
 
8,267

Net (redemptions/distributions paid to)/subscriptions received from noncontrolling interest holders
 
(2,300
)
 
649

Balance, end of period
 
$
21,549

 
$
45,628


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 Legg Mason's 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 September 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
 
$
535,977

 
$

 
$

 
$
535,977

Time deposits
 

 
102,481

 

 
102,481

Total cash equivalents
 
535,977

 
102,481

 

 
638,458

Investment securities:
 
 

 
 

 
 

 
 

Trading investments relating to long-term incentive compensation plans(2)
 
92,999

 

 

 
92,999

Trading proprietary fund products and other investments(3)
 
119,940

 
79,304

 

 
199,244

Equity method investments relating to long-term incentive compensation plans, proprietary fund products and other investments(4)(5)
 
12,402

 
38,005

 
11,705

 
62,112

Total current investments
 
225,341

 
117,309

 
11,705

 
354,355

Available-for-sale investment securities(6)
 
2,102

 
10,290

 
12

 
12,404

Investments in partnerships, LLCs and other(6)
 
1,008

 
2,517

 
28,041

 
31,566

Equity method investments in partnerships and LLCs(4)(6)
 
1,375

 
4

 
129,294

 
130,673

Derivative assets:
 
 
 
 
 


 
 

Currency and market hedges
 
939

 

 

 
939

Other investments(6)
 

 

 
119

 
119

 
 
$
766,742

 
$
232,601

 
$
169,171

 
$
1,168,514

Liabilities:
 
 
 
 
 
 
 
 
Derivative liabilities:
 
 
 
 
 
 
 
 
Currency and market hedges
 
$
(907
)
 
$

 
$

 
$
(907
)



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(6)
 
2,091

 
9,810

 
12

 
11,913

Investments in partnerships, LLCs and other(6)
 
851

 
5,351

 
28,763

 
34,965

Equity method investments in partnerships and LLCs(4)(6)
 
1,415

 
1,348

 
166,438

 
169,201

Derivative assets:
 
 
 
 
 
 
 
 

Currency and market hedges
 
84

 

 

 
84

Other investments(6)
 

 

 
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 52% and 48% in equity and debt securities, respectively, as of both September 30, 2012 and March 31, 2012.
(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 $38,005 and $54,934 as of September 30, 2012 and March 31, 2012, respectively, and proprietary fund products and other investments of $24,107 and $23,343 as of September 30, 2012 and March 31, 2012, respectively, which are classified as Investment securities on the Consolidated Balance Sheets.
(6)
Amounts are included in Other non-current assets on the Consolidated Balance Sheets for each of the periods presented.

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 and six months ended September 30, 2012 and 2011, are presented in the tables below:
 
 
Value as of June 30, 2012
 
Purchases
 
Sales
 
Redemptions/Settlements/ Other
 
Transfers
 
Realized and unrealized gains/(losses), net
 
Value as of September 30, 2012
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Equity method investments in proprietary fund products
 
$
11,296

 
$

 
$

 
$

 
$

 
$
409

 
$
11,705

Investments in partnerships, LLCs and other
 
28,513

 

 
(788
)
 
(415
)
 

 
731

 
28,041

Equity method investments in partnerships and LLCs
 
160,602

 
122

 
(204
)
 
(45,488
)
 

 
14,262

 
129,294

Other investments
 
128

 

 

 

 

 
3

 
131

 
 
$
200,539

 
$
122

 
$
(992
)
 
$
(45,903
)
 
$

 
$
15,405

 
$
169,171


 
 
Value as of June 30, 2011
 
Purchases
 
Sales
 
Redemptions/Settlements/ Other
 
Transfers
 
Realized and unrealized gains/(losses), net
 
Value as of September 30, 2011
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Trading proprietary fund products and other investments
 
$
280

 
$

 
$
(100
)
 
$

 
$

 
$
(1
)
 
$
179

Equity method investments in proprietary fund products
 
12,240

 

 

 

 

 
(635
)
 
11,605

Investments in partnerships, LLCs and other
 
21,952

 
7,038

 

 

 

 
(521
)
 
28,469

Equity method investments in partnerships and LLCs
 
143,107

 
24,174

 
(1,636
)
 
(619
)
 

 
(4,364
)
 
160,662

Other investments
 
1,254

 

 

 
(159
)
 

 
(962
)
 
133

 
 
$
178,833

 
$
31,212

 
$
(1,736
)
 
$
(778
)
 
$

 
$
(6,483
)
 
$
201,048



12



 
 
Value as of March 31, 2012
 
Purchases
 
Sales
 
Redemptions/ Settlements/ Other
 
Transfers
 
Realized and unrealized gains/(losses), net
 
Value as of September 30, 2012
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Equity method investments in proprietary fund products
 
$
11,778

 
$

 
$

 
$

 
$

 
$
(73
)
 
$
11,705

Investments in partnerships, LLCs and other
 
28,763

 

 
(788
)
 
(566
)
 

 
632

 
28,041

Equity method investments in partnerships and LLCs
 
166,438

 
212

 
(842
)
 
(52,066
)
 

 
15,552

 
129,294

Other investments
 
124

 

 

 

 

 
7

 
131

 
 
$
207,103

 
$
212

 
$
(1,630
)
 
$
(52,632
)
 
$

 
$
16,118

 
$
169,171

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

 
$

 
$
(11,741
)
 
$

 
$

 
$
542

 
$
179

Equity method investments in proprietary fund products
 
12,167

 

 

 

 

 
(562
)
 
11,605

Investments in partnerships, LLCs and other
 
22,167

 
6,932

 

 
(109
)
 

 
(521
)
 
28,469

Equity method investments in partnerships and LLCs
 
153,931

 
25,504

 
(3,293
)
 
(12,697
)
 

 
(2,783
)
 
160,662

Other investments
 
282

 

 

 
(159
)
 

 
10

 
133

 
 
$
199,925

 
$
32,436

 
$
(15,034
)
 
$
(12,965
)
 
$

 
$
(3,314
)
 
$
201,048


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 (losses) for Level 3 investments relating only to those assets still held at the reporting date were $15,145 and $(6,487) for the three months ended September 30, 2012 and 2011, respectively. Total unrealized gains (losses) for Level 3 investments relating only to those assets still held at the reporting date were $16,429 and $(5,419) for the six months ended September 30, 2012 and 2011, respectively.

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

13



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 September 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 September 30, 2012
Category of Investment
 
Investment Strategy
 
September 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
 
$
46,184

(1)
$
51,251

(2)
n/a

 
n/a
Hedge funds
 
Fixed income - developed market, event driven, fixed income - hedge, relative value arbitrage, European hedge
 
25,163

 
25,460

 
$
20,000

 
n/a
Private equity funds
 
Long/short equity
 
27,002

(3)
27,927

(3)
6,140

 
Up to 8 years
Private fund
 
Fixed income, residential and commercial mortgage-backed securities
 
63,849

 
89,323

 
n/a

 
6 years, subject to two one-year extensions (4)
Other
 
Various
 
2,330

 
2,450

 
n/a

 
Various (5)
Total
 
 
 
$
164,528

(6
)
$
196,411

(6
)
$
26,140

 
 
n/a-not applicable
(1)
59% monthly redemption; 41% quarterly redemption, of which 38% is subject to two-year lock-up, which expires in June 2013.
(2)
63% monthly redemption; 37% quarterly redemption, of which 36% is subject to two-year lock-up, which expires in June 2013.
(3)    Liquidations are expected over the remaining term.
(4) Upon liquidation of the fund, Legg Mason's investment is expected to be fully redeemed in the quarter ended December 31, 2012.
(5)
Of this balance, 4% has a remaining term of less than one year and 96% has a remaining term of 20 years.
(6)
Comprised of approximately 15% and 85% of Level 2 and Level 3 assets, respectively, as of September 30, 2012 and 13% and 87% of Level 2 and Level 3 assets, respectively, as of March 31, 2012.

There are no current plans to sell any of these investments held as of September 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:
 
 
September 30, 2012
 
March 31, 2012
Equipment
 
$
156,471

 
$
155,173

Software
 
216,043

 
205,760

Leasehold improvements
 
245,983

 
242,566

Total cost
 
618,497

 
603,499

Less: accumulated depreciation and amortization
 
(388,515
)
 
(364,088
)
Fixed assets, net
 
$
229,982

 
$
239,411


Depreciation and amortization expense included in operating income was $12,896 and $16,662 for the three months ended September 30, 2012 and 2011, respectively, and $26,471 and $33,963 for the six months ended September 30, 2012 and 2011, respectively.



14



5. Intangible Assets and Goodwill

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

 
 

Cost
 
$
205,880

 
$
206,411

Accumulated amortization
 
(179,452
)
 
(172,974
)
Net
 
26,428

 
33,437

Indefinite–life intangible assets
 
 

 
 

Fund management contracts
 
3,753,688

 
3,753,629

Trade names
 
69,800

 
69,800

 
 
3,823,488

 
3,823,429

Intangible assets, net
 
$
3,849,916

 
$
3,856,866


As of September 30, 2012, amortizable asset management contracts are being amortized over a weighted-average remaining life of 2.6 years.

Estimated amortization expense for each of the next five fiscal years is as follows:
Remaining 2013
 
$
7,010

2014
 
11,835

2015
 
2,920

2016
 
2,663

2017
 
2,000

Thereafter
 

Total
 
$
26,428


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
 
(10,792
)
 

 
(10,792
)
Other, including changes in foreign exchange rates
 
(8,107
)
 

 
(8,107
)
Balance as of September 30, 2012
 
$
2,418,046

 
$
(1,161,900
)
 
$
1,256,146





15



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 of 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 September 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 September 30, 2012, Legg Mason's net debt to EBITDA ratio was 1.4 to 1 and EBITDA to interest expense ratio was 12.4 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 September 30, 2012 was 1.7%.
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, requires additional interest up to 0.50% over the stated rate. As of September 30, 2012, the interest rate was 5.75%, which includes 0.25% associated with the registration status of the Senior Notes. 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 then 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 six months ended September 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

16



the aggregate and subject to adjustment, of 14,205 shares of Legg Mason common stock, on a net share settled basis, at an 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. Legg Mason has had the ability to settle its obligations under the Warrants with Legg Mason common stock. Accordingly, the Warrants are 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:
 
 
September 30, 2012
 
March 31, 2012
 
 
Current Accreted Value
 
Unamortized Discount
 
Maturity Amount
 
Accreted Value
5.5% senior notes
 
$
643,590

 
$
6,410

 
$
650,000

 
$

Five-year term loan
 
500,000

 

 
500,000

 

Other term loans
 
9,249

 

 
9,249

 
9,883

2.5% convertible senior notes
 

 

 

 
1,127,009

Subtotal
 
1,152,839

 
6,410

 
1,159,249

 
1,136,892

Less: current portion
 
58,372

 

 
58,372

 
1,278

Total
 
$
1,094,467

 
$
6,410

 
$
1,100,877

 
$
1,135,614


As of September 30, 2012, the aggregate maturities of long-term debt, based on their contractual terms, are as follows:
Remaining 2013
 
$
8,373

2014
 
50,438

2015
 
50,438

2016
 
50,000

2017
 
50,000

Thereafter
 
950,000

Total
 
$
1,159,249


At September 30, 2012, the estimated fair value of long-term debt was $1,206,218, and is classified as Level 2 in the fair value hierarchy.

Prior to the repurchase of the Notes in May 2012, 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 $9,741 for the three months ended September 30, 2011, and $5,839 and $19,230 for the six months ended September 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. Shares available for issuance under the active equity incentive stock plan as of September 30, 2012, were 10,543. 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 September 30, 2012 and 2011, was $2,619 and $3,500, respectively, and for the six months ended September 30, 2012 and 2011, was $5,902 and $7,681, respectively.


17



Stock option transactions during the six months ended September 30, 2012, and 2011, respectively, are summarized below:
 
 
Six Months Ended September 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
 
(1
)
 
23.72

 
(8
)
 
25.76

Canceled/forfeited
 
(578
)
 
56.37

 
(305
)
 
47.95

Options outstanding at September 30
 
6,011

 
$
52.44

 
5,916

 
$
56.95


At September 30, 2012, options were exercisable on 3,586 shares, with a weighted-average exercise price of $68.60 and a weighted-average remaining contractual life of 3.1 years. Unamortized compensation cost related to unvested options (2,425 shares) at September 30, 2012, was $22,912 and is expected to be recognized over a weighted-average period of 1.8 years.

The weighted-average fair value of stock option grants during the six months ended September 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:
 
 
Six Months Ended September 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 September 30, 2012 and 2011, was $11,715 and $8,533, respectively, and for the six months ended September 30, 2012 and 2011, was $21,022 and $16,608, respectively.

Compensation expense for the three and six months ended September 30, 2012 includes approximately $1,800 of accelerated stock-based net compensation costs associated with Legg Mason's Chief Executive Officer stepping down in September 2012.

Restricted stock and restricted stock unit transactions during the six months ended September 30, 2012 and 2011, respectively, are summarized below:
 
 
Six Months Ended September 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
 
2,183

 
24.04

 
1,315

 
33.79

Vested
 
(903
)
 
32.26

 
(700
)
 
33.86

Canceled/forfeited
 
(37
)
 
29.74

 
(42
)
 
33.06

Unvested shares at September 30
 
4,116

 
$
29.02

 
3,210

 
$
33.14


Unamortized compensation cost related to unvested restricted stock and restricted stock unit awards at September 30, 2012 of $92,112 is expected to be recognized over a weighted-average period of 1.8 years. In connection with the change in Legg

18



Mason's Chief Executive Officer, in September 2012 325 shares of restricted stock were granted to certain executives and key employees, with an aggregate value of $8,400. These shares vest on March 31, 2014, and are intended to retain and motivate these employees.

Compensation expense relating to the stock purchase plan and deferred compensation payable in stock for the three months ended September 30, 2012 and 2011, was $92 and $109, respectively, and for the six months ended September 30, 2012 and 2011, was $236 and $284, respectively.

During the six months ended September 30, 2012 and 2011, non-employee directors were granted 16 and 12 restricted stock units and 35 and 31 shares of common stock at a fair value of $1,250 and $1,375, respectively. As of September 30, 2012 and 2011, non-employee directors held 112 and 193 stock options, respectively, which are included in the outstanding options presented in the table above. As of September 30, 2012 and 2011, non-employee directors held 90 and 74 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. During the six months ended September 30, 2012 and 2011, non-employee directors did not exercise any stock options and no restricted stock units were distributed. During the six months ended September 30, 2012 and 2011, there were 72 and 27 non-employee director stock options canceled or forfeited, respectively.

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 and the September 2012 quarter that will vest at the end of their respective three year periods based upon Legg Mason's cumulative adjusted earnings per share over the respective periods. 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 amounts of the awards, if any, are expensed over the future vesting periods 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. The portion of the awards subject to accelerated vesting was revalued and expensed over the new vesting period, the impact of which is included above in fiscal year 2012.

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 September 30, 2012, the minimum annual aggregate rentals under operating leases and service agreements are as follows:
Remaining 2013
 
$
75,216

2014
 
125,876

2015
 
115,892

2016
 
103,671

2017
 
93,843

Thereafter
 
510,693

Total
 
$
1,025,191


The minimum rental commitments shown above have not been reduced by $158,496 for minimum sublease rentals to be received in the future under non-cancelable subleases, of which approximately 46% 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.


19



The above minimum rental commitments include $930,855 in real estate and equipment leases and $94,336 in service and maintenance agreements.

As of September 30, 2012, Legg Mason had commitments to invest approximately $36,891 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 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 determined based on current information, after consultation with legal counsel, management believes that any accrual or range of reasonably possible losses as of September 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, previously scheduled for April 2013, has been moved to July 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 the action will not have a material effect on Legg Mason's financial position, results of operations or cash flows.

Another matter relates to two related regulatory investigations of one of Legg Mason's asset management subsidiaries regarding its compliance with applicable legal requirements with respect to an investment made for certain client accounts. Legg Mason believes that it handled the investment appropriately and is continuing discussions to resolve the matter. Although the ultimate resolution is unknown, Legg Mason has reserved $4 million as a probable outcome. Legg Mason also believes this matter would likely be covered by insurance policies that may substantially mitigate the amount of any eventual loss, but as is not unusual with regulatory proceedings at this point in the process, there can be no assurance that this matter will not have a material effect on Legg Mason's financial position, results of operations or cash flows.

Legg Mason cannot estimate the reasonably possible additional loss or range of loss associated with the ultimate resolution of the two matters above, or certain other matters described above as customer complaints, legal actions, inquires, proceedings and investigations. The inability to provide a reasonably possible amount or range of losses is not because there is uncertainty as to the ultimate outcome of a matter, but because liability and damage issues have not developed to the point where Legg Mason can conclude that there is both a reasonable possibility of a loss and a meaningful amount or range of possible losses.

20



There are numerous aspects to customer complaints, legal actions, inquiries, proceedings and investigations that prevent Legg Mason from estimating a related amount or range of reasonably possible losses. These aspects include, among other things, the very nature of the matters; that significant relevant facts are not known, are uncertain or are in dispute; and that damages sought are not specified, are uncertain, unsupportable or unexplained. In addition, for legal actions, discovery may not yet have started, may not be complete or may not be conclusive, and meaningful settlement discussions may not have occurred. Further, for regulatory matters, investigations may run their course without any clear indication of wrongdoing or fault until their conclusion.

In management's opinion, an adequate accrual has been made as of September 30, 2012, to provide for any probable losses that may arise from matters for which the Company could reasonably estimate an amount. 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 Attributable to Legg Mason, Inc. by the weighted-average number of shares outstanding. The calculation of weighted-average shares includes common shares 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.

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 completion of the repurchase of the then 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 and six months ended September 30, 2012, Legg Mason purchased and retired 3,554 and 9,727 shares of its common stock for $90,071 and $245,071, respectively, through open market purchases, which completed the repurchase of its common stock under the previous authorization, and began purchases under the new authorization. These repurchases reduced weighted-average shares outstanding by 7,718 and 4,953 shares for the three and six months ended September 30, 2012, respectively. The par value of the shares repurchased is charged to common stock, with the excess of the purchase price over par first charged against additional paid-in capital, with the remaining balance, if any, charged against retained earnings.

In connection with the change in its Chief Executive Officer in September 2012, Legg Mason issued 325 shares of restricted stock, during the three months ended September 30, 2012 to certain executives and key employees to retain and motivate these employees. During the six months ended September 30, 2012, Legg Mason issued 2,167 shares of restricted stock related to its annual incentive awards and the retention awards mentioned above. Of the shares issued in the six month period, 1,917 and 1,427 shares are included in weighted-average shares outstanding for the three and six months ended September 30, 2012, respectively. Legg Mason issued 56 and 1,303 shares, respectively, of restricted stock related to its annual incentive awards, during the three and six months ended September 30, 2011. Of the shares issued in the six month period, 1,286 and 960 shares are included in weighted-average shares outstanding for the three and six months ended September 30, 2011, respectively.

In June 2011, Legg Mason issued 1,830 shares of common stock upon the exercise of purchase contracts on the remaining outstanding Equity Units issued in May 2008. Of these shares, 1,830 and 930 shares are included in weighted-average shares outstanding for the three and six months ended September 30, 2011.


21



The following table presents the computations of basic and diluted EPS:
 
 
Three Months Ended September 30,
 
 
2012
 
2011
 
 
Basic
 
Diluted
 
Basic
 
Diluted
Weighted-average basic shares outstanding
 
134,098

 
134,098

 
143,877

 
143,877

Potential common shares:
 
 
 
 
 
 
 
 
Employee stock options
 

 
30

 

 
54

Weighted-average diluted shares
 
134,098

 
134,128

 
143,877

 
143,931

Net Income
 
$
81,095

 
$
81,095

 
$
57,383

 
$
57,383

Less: Net income attributable to noncontrolling interests
 
298

 
298