Annual Report | 2014
MOMENTUM
If the wind will not serve, take to the oars.
—Latin proverb
INDEPENDENT INVESTMENT AFFILIATES + GLOBAL RETAIL DISTRIBUTION
London
Frankfurt
Warsaw
Paris
Geneva
Milan
Madrid
Montreal
Toronto
San Francisco
Cincinnati
Pasadena
Boston
Stamford
New York
Philadelphia
Wilmington
Baltimore
Miami
Beijing
Shanghai
Tokyo
Dubai
Hong Kong
Taipei
Singapore
2,800
EMPLOYEES
29
CITIES
COUNTRIES MOMENTUM
190
Investment Centers (21)
Distribution Locations (16)
São Paulo
Santiago
We are one of the world’s largest asset managers. We have a local presence
in 29 cities around the globe, serving individual and institutional investors
located in 190 countries across six continents. Our global distribution network,
combined with our diverse family of specialized investment managers, creates
a strong platform to deliver performance.
Melbourne
DEAR CLIENTS AND FELLOW SHAREHOLDERS:
I write you following the completion of my first year as CEO, very pleased
to share the results of a year of great progress for our Legg Mason.
During this past year, I have been so proud to see our organization move
forward, together, in service of our clients and shareholders, as we begin
returning Legg Mason to a position of industry leadership. This new fiscal
year, it is our commitment to build further on the clear momentum that
we now enjoy.
Our Fiscal 2014 was a year of difficult but important decisions that
involved streamlining our Company where appropriate, while adding
resources and capabilities opportunistically, all with a clear focus on
“Building a Better Legg Mason” and positioning the Company for
growth: our number one priority for Fiscal 2015.
As we look ahead, fully appreciating the sacred trust our clients place in
us, we feel an even greater sense of purpose and determination to help
solve the financial challenges we all face: achieving financial security and
growth in what remains a turbulent global economy.
We strongly believe that we have the talent and resources, properly
aligned and focused, to help our clients navigate these challenges.
We remain confident that our business model, combining highly-
performing, independent investment managers and global retail distribution,
is not only differentiated in the marketplace, but distinctive. This model,
successfully executed, provides the foundation to deliver for clients and,
in turn, our shareholders, in two essential ways: by achieving compelling
investment returns in appropriate products and strategies that are
effectively distributed on a global basis. We are quite pleased to have
made progress on both investment performance and distribution last year,
and we expect to build upon those improvements in the year ahead.
We see the Legg Mason of the future with fewer but larger Affiliates,
focused on delivering compelling investment results for investors, more
comprehensive investment capabilities that reflect evolving client demand
and needs, and an increasingly productive operating team to support
both our Affiliates and global distribution platform. We believe that
strong execution of this vision will improve our organic AUM growth rate;
increase revenue generation; and further diversify our business by client,
asset class and geography to yield increasingly better results for both our
clients and fellow shareholders this coming year and beyond.
The Year in Review: Change and Action
Our work this past year was one of deliberate action, centered on three
fundamental imperatives: improving operating productivity, leveraging
our global distribution platform and strengthening our independent, multi-
Affiliate model to be more competitive and effective.
Leadership Changes —We strengthened our Board of Directors with the
addition of our new non-executive Chairman, Dennis Kass, and Directors
John Myers, John Murphy and John Davidson (elected in May), all of
whom add diverse and broad business and asset management expertise.
Joseph A. Sullivan
President and Chief Executive Officer
1Legg Mason I’m grateful for the insight and counsel of these new Directors
and look forward to our collaboration as we progress.
Additionally, I am very pleased that Tom Hoops joined Legg
Mason to lead the critical business and product development
effort at the senior executive level. Having most recently
managed the Affiliated Managers Division within the
asset management group at Wells Fargo, Tom appreciates
our diverse, multi-Affiliate model and, as such, is quite
comfortable and effective in bringing together our Affiliates,
the executive team and the broader organization around
common objectives.
Improving Operating Productivity—We introduced
a LEAN/Six Sigma efficiency initiative to the Company
that resulted in both short- and long-term benefits to
the organization. Several hundred employees worldwide
were trained to lead an evolution of our corporate DNA
to embrace the practice of Kaizen, or “continuous
improvement.” The Legg Mason of the future is committed
to operating the firm with a high degree of efficiency and
effectiveness, which is more than just a matter of fiscal
prudence, but also a competitive necessity. This important
productivity initiative has already yielded a meaningful
reduction in our spend, which we are redeploying to our
critical growth engine, Legg Mason Global Distribution.
Leveraging Our Global Distribution Platform—It is clear
that we now operate in a more complex market environment
with low real economic growth and interest rates,
particularly in mature economies. This sober reality means
that, to accomplish their long-term objectives, investors
need to consider looking across asset classes and beyond
the borders of regional geographies in new ways when
investing. This is the real “new reality” that our investor
clients face, and the implications for asset managers
are significant. Size, reach and diversity of products and
strategies are essential to meet these evolving client needs;
and managers that offer a broad, truly global perspective and
investment strategy palette will succeed disproportionately
in the marketplace.
We believe that Legg Mason is competitively positioned to
capture just such opportunity.
While still in modest long-term outflow, we made
significant progress this past year in distribution across
the Company, with net long-term asset flows improving
by approximately $28 billion. Strong performance in both
our institutional and retail channels was highlighted by
our global retail platform achieving record gross sales,
increasing 15% over the prior year.
Despite that improvement, we believe that we can
dramatically grow our sales and improve net flows over the
next few years, but to do so will require thinking and acting
differently, embracing change as our clients and the markets
change. Specifically, to better serve a larger and broader set
of global clients, our sales and client service teams must
have even deeper product knowledge, listen and engage with
our clients more effectively, and be better prepared to offer
innovative products and solutions that meet their needs.
In addition to working harder and being opportunistic,
“winning” firms will also need to work smarter, with costs
for all managers rising, as more is expected of us by clients,
distribution partners and regulators than ever before.
In working smarter, we are investing thoughtfully and
strategically to innovate and harness the power of
technology, enabling us to better understand and serve our
clients more effectively and efficiently.
Utilizing technology to collect and analyze client
segmentation and geographic dispersion data, we created
The Board’s Perspective
Your Company concluded this fiscal year with strong and
improving business and financial results. Assets under
management increased because of positive stock market trends,
broadly competitive investment performance and dramatic
improvement in net flows. Rising revenues, continued expense
discipline and prudent capital management have driven higher
profitability and favorable absolute and relative returns for
investors in Legg Mason.
CEO Joe Sullivan has led strategic initiatives to significantly
enhance investment and distribution capabilities—creating
a more focused Affiliate lineup, increasing product offerings
through innovation and acquisitions, and expanding the
Company’s reach in global distribution channels. Your Board
enthusiastically supports his plans to foster investment excellence
firm-wide, improve the quality and efficiency of business
operations, and accelerate the growth of revenues and profits.
We sincerely thank Harold Adams, John Koerner and John
Cahill for their superb and diverse contributions as Directors of
Legg Mason. In the fiscal year, we welcomed two new Directors
to the Board: John Myers and John Murphy, both veteran
industry leaders; and in May we welcomed John Davidson, a
seasoned financial executive and public company director.
The Board will remain vigilant in working to fulfill our
fiduciary responsibilities of supervision and oversight, on behalf
of you, the owners of Legg Mason.
Respectfully,
Dennis M. Kass
Chairman of the Board
2Legg Mason Financial Highlights
(dollars in thousands, except per share amounts)
Years Ended March 31,
OPERATING RESULTS
Operating revenues
Operating income (loss)
Income (loss) from continuing operations before
income tax provision (benefit)
Net income (loss) attributable to Legg Mason, Inc.(1)
Adjusted income(2)
PER COMMON SHARE
Net income (loss), diluted(1)
Adjusted income, diluted(2)
Dividends declared
Book Value
FINANCIAL CONDITION
Total assets
Total stockholders’ equity
2014
2013
2012
2011
2010
$2,741,757
$2,612,650
$2,662,574
$2,784,317
$2,634,879
430,893
(434,499)
338,753
386,808
321,183
419,641
(510,607)
303,083
365,197
329,656
284,784
417,805
(353,327)
347,169
220,817
397,030
253,923
439,248
204,357
381,258
$ 2.33
$ (2.65)
$ 1.54
$ 1.63
$ 1.32
3.41
0.52
40.32
2.61
0.44
38.44
2.77
0.32
40.59
2.83
0.20
38.41
2.45
0.12
35.94
$7,111,349
$7,269,660
$8,555,747
$8,707,756
$8,622,632
4,724,724
4,818,351
5,677,291
5,770,384
5,841,724
(1) Fiscal 2013 includes non-cash impairment charges related to intangible assets, net of income tax benefits, of $508,252 or $3.81 per share.
(2) Adjusted income, per diluted share represents a performance measure that is based on a methodology other than generally accepted accounting principles
(“non-GAAP”). For more information regarding this non-GAAP financial measure, see Management’s Discussion and Analysis of Financial Condition and
Results of Operations included in this Annual Report.
a differentiated U.S. distribution model. As part of this
work, we segmented the business needs of nearly 200,000
advisors in the U.S. retail market, including both those we
now serve and those whom we’ve identified as having
significant business potential. Further, we are applying the
lessons we’ve learned in the meaningful success of our
innovative “cross channel” sales model, launched in 2011.
Given that success, our conviction is high that multiple
coverage models can succeed and lift the productivity of all
sales teams to create a more powerful distribution system.
We’ve introduced a new solutions-oriented, capital markets-
based selling approach and a modified sales compensation
plan to support it. Going forward, we will use metrics to
reinforce collaboration throughout the organization and
strengthen accountability for results.
We’re very excited about the opportunity to accelerate our
success in our global distribution platform with the launch in
April of these new sales initiatives in the United States, and
we will apply a similar, though regionally adapted, approach
internationally in the year ahead.
Strengthening Our Independent Multi-Affiliate Model—
While firmly committed to our independent, multi-Affiliate
model, we recognize that there is room for meaningful
improvement in how we execute this model. The economic
structure, the relationship governance and mix of our
Affiliate portfolio must be modified and enhanced.
With that in mind, we successfully completed two
Management Equity Plans with Permal and ClearBridge
during the year to create greater alignment in building long-
term franchise value at the Affiliate level.
These plans are designed to improve the Affiliate’s ability to
recruit and retain talent, support succession planning and
yield incremental margin for Legg Mason shareholders, as
the Affiliate grows. We expect to complete similar plans
with each of our major Affiliates.
At the same time, we substantially modified the mix of our
Affiliate portfolio by rationalizing non-strategic, sub-scale
and underperforming managers and adding new investment
capabilities, through a series of difficult but important actions.
To address small or non-core Affiliates in a thoughtful
manner, we reached an agreement to sell Private Capital
Management back to its management team in August and
made the decision to wind down operations at our London-
based emerging market Affiliate, Esemplia, last fall.
Additionally, we combined Legg Mason Capital Management
with ClearBridge Investments, rebranding LMCM products
under the ClearBridge name. We will now leverage their
shared history and success, focused on fundamental
investing, under a single brand.
In March, we were very pleased to announce the acquisition
of QS Investors, which was completed in May, bringing to
Legg Mason a leading manager of customized solutions and
global quantitative equities. We are very fortunate to add
3Legg Mason Executive
Committee
Legg Mason’s Executive
Committee is composed of
(left to right) Tom Merchant,
General Counsel; Tom
Hoops, Head of Business
Development; Joe Sullivan,
Chief Executive Officer;
Jennifer Murphy, Chief
Administrative Officer; Pete
Nachtwey, Chief Financial
Officer; and Terry Johnson,
Head of Global Distribution.
this highly talented team with a distinctive and differentiated
investment process and a scalable, proprietary investment
platform capable of accommodating significant growth.
our Affiliate lineup, but only if and as we find a quality firm
with a leverageable investment platform, again, with a focus
on having fewer and larger Affiliates.
In tandem with the acquisition of QS, we have begun the
process of combining, over time, the investment capabilities
and operations of QS with those of Batterymarch Financial,
our existing quantitative equity manager, and Legg Mason
Global Asset Allocation, our multi-manager platform. We’re
confident that the combined platform, bringing together
the best of these three firms, will powerfully position Legg
Mason to meet the rapidly growing client demand for global
solutions, liquid alternatives and smart beta categories.
Each of these actions involved difficult but necessary
decisions that have helped streamline our Affiliate lineup
and clarify our brand in the marketplace. As a result, we
now have six larger, highly focused Affiliates in Brandywine
Global, ClearBridge Investments, Permal, QS Investors,
Royce & Associates and Western Asset Management, each
with a distinct investment expertise and brand.
And, as it relates to expanding and refining our investment
capabilities and Affiliate mix, we’re not done.
We do expect to continue adding investment capability
through lift-outs and bolt-ins and will likely add modestly to
As we expand our investment capability, we seek to add
investment professionals and new Affiliate relationships with
people and firms that are entrepreneurial and innovative, that
deliver compelling investment results for investors, whose
culture is consistent with our clients first commitment and
who seek the benefits of a true partnership with a large,
global firm.
While these attributes represent a high bar for admission,
we believe that Legg Mason is a wonderful home for
great investors. Our current Affiliates share these critical
characteristics and are aligned with us in strong partnership
to serve our clients, a mutual commitment that will drive our
collective success.
We’re proud of the significant and successful work on these
three critical imperatives this past year and are confident that
we are now better positioned in the marketplace, realizing
that the heavy lifting of growth has just begun.
Year in Review: Business and Financials
We are certainly pleased with the performance of our stock
over the past year, which we believe reflects significant
4
Legg Mason
progress on the three fundamental imperatives and
improvement on key business metrics.
Most importantly, investment performance remained strong
overall, with three-quarters or more of our strategy AUM
exceeding benchmarks for all time periods as of year-end.
Our results include an improvement of $28 billion in long-
term net flows. This improvement, led by fixed income
inflows and significantly reduced equity outflows, resulted
in a modest total outflow for the fiscal year.
outcome-oriented products that our clients want, both
through QS’s own expertise and through partnerships with
our other investment Affiliates.
We intend to complete more Management Equity Plans
in the coming year, as doing so aligns the Company more
deeply with our Affiliates, provides a mechanism for long-
term growth and sustainability and, very importantly, affords
Legg Mason the opportunity to achieve incremental margin
as each Affiliate grows.
We achieved a 5% increase in revenues and a meaningful
improvement in our operating margin, as adjusted, year
over year.
We fully expect continued improvement in distribution in
both the institutional and retail channels and are investing
thoughtfully and meaningfully to support that growth.
For Fiscal Year 2014, Legg Mason reported net income
of $285 million, or $2.33 per diluted share, and adjusted
income of $418 million, or $3.41 per diluted share.
And finally, as we run our business, we will continue to
pursue managing this Company with the highest degree of
efficiency and effectiveness possible…Kaizen!
Assets under management at fiscal year-end were
$702 billion, up 6% from March 2013.
We refinanced our debt, deleveraged our balance sheet and
locked in long-term debt capital at current historically low rates.
While we seek to deliver on these operating goals, we’ll
continue to appropriately balance the allocation of our capital
between investing in the business for the long term and
returning it to shareholders.
Finally, over the past year we returned capital to
shareholders by repurchasing 9.7 million shares and
increasing our dividend by 23%.
We are very pleased that over the past three years the
combination of our share buyback and dividend has
resulted in Legg Mason delivering one of the highest total
shareholder payout rates in the industry.
The Year Ahead
As an asset management firm, we generate a significant
amount of cash that we can return to shareholders and
invest strategically in future growth, which is the foundation
of Building a Better Legg Mason.
In the year ahead, we remain committed to continuing to
fill investment capability gaps, most importantly in non-
U.S. equities, a goal that remains very high on my personal
list of priorities.
We will also continue to look thoughtfully and opportunis-
tically at adding alternative investment capabilities in such
asset classes as real estate, energy and private equity.
I am extremely proud of the dedication and commitment
of our nearly 3,000 professionals around the world, as
they continue to work tirelessly to serve both our clients
and shareholders.
We recognize the many challenges faced by investors
today, challenges that may, at times, seem almost
overwhelming. We have the resources, the capability and
the opportunity to play a meaningful role with investors to
solve many of these challenges. This opportunity is also a
responsibility to lead, to bring more to the clients we now
serve and to reach more investors around the world. In
fulfilling this responsibility, we will return our Legg Mason
to organic growth, to the benefit of the clients we serve,
our shareholders and our fellow colleagues. We eagerly
and gratefully accept this important responsibility.
We appreciate your continued trust and confidence.
We are excited about the potential for the solutions
capability we now have with QS Investors to deliver the
Joseph A. Sullivan
President and Chief Executive Officer
Legg Mason
5
Global value investing
Pursuing value since 1986 across equity and
fixed-income, globally and in the United
States. Historically institutionally focused,
the firm has both a boutique’s agility and a
leader’s stability and resources.
Assets by Strategy
Fixed Income—79%
Diversified Equity—9%
Large Cap Equity—9%
Small/Mid Cap Equity—3%
Quality focused equity
Global investment manager with over 45
years of experience and long-tenured portfolio
managers who seek to build income, high
active share or low volatility portfolios.
Assets by Product Type
High Active Share*—51%
Income Solutions—26%
Low Volatility—23%
*Active share is a measure of the percentage of stock holdings in a manager’s portfolio that differs from the benchmark index.
Global alternative asset manager
Permal Group is a leading global alternative
asset manager offering investment
solutions through established funds and
customized portfolios.
6
Legg Mason
Multi-Manager Funds’
Assets by Strategy
Global Macro—30%
Fixed Income—21%
Global Long/Short—21%
Event Driven—19%
Thematic—3%
Equity Long—2%
Natural Resources—1%
Cash/Other—3%
Brandywine Global’s momentum in Fiscal 2014 came from a focus on culture, investment research and
reinvestment in the business. Its strong culture led Pensions & Investments to recognize Brandywine as one of
the “Best Places to Work.” Brandywine added 50 talented professionals to its team and thoughtfully executed
its research agenda, such that 97% of the firm’s clients outperformed their indexes since inception.
The firm also expanded its global reach, opening offices in Montreal and Toronto. As of March 31, 2014, over 43%
of the firm’s assets come from 20 countries outside of the United States, while over 68% of assets are managed in
global mandates. The firm also substantially grew its sub-advisory business, and now manages $17 billion in
mutual fund and UCITS assets, an increase of 15% over fiscal year-end 2013.
All of this led to the ultimate form of sustainable momentum: client satisfaction. The firm’s assets rose to $52 billion,
its highest ever.
ClearBridge Investments is an active global equity manager with more than $90 billion in assets under management.
During the year, ClearBridge’s long-tenured portfolio managers and fundamental research team continued to focus
on building portfolios for clients around income solutions, high active share and managed volatility.
An improved equity environment, ClearBridge’s consistent investment discipline and an ongoing commitment to
reinvesting in its business drove its success throughout the year. Long-term competitive investment results across
client portfolios resulted in new flows of more than $9 billion across portfolio strategies. ClearBridge also expanded
its business globally, particularly in Asia and Europe, in conjunction with Legg Mason Global Distribution.
ClearBridge operates with investment independence from its headquarters in New York and offices in Baltimore,
San Francisco and Wilmington. ClearBridge portfolio managers are among the most seasoned in the industry,
having an average of 25 years of investment experience and 19 years at the firm.
The past year has been marked by highly significant developments. Permal acquired Fauchier Partners, a leading
European-based, institutionally focused alternative manager, and successfully merged it into the Group. Permal
further enhanced its position as an industry innovator, launching various new products across the liquidity
spectrum, including a two-year lock-up fund focused on opportunistic investing, as well as a daily liquid fund—
Permal Alternative Select Fund—its first open-end alternative mutual fund. The growth of corporate activism has
been a core theme that has played throughout the year, both across Permal’s portfolios and in a dedicated fund.
Elsewhere, there was further development on the buyside managed account platform (PMAP), which grew to
$8.2 billion, increasing 24% over the past year, and there are now 86 accounts, divided into pari passu and
customized exposures. Permal also has built out its customized mandate business, which now accounts for
approximately $4 billion of Permal’s assets, and is core to the future as investors look to alternative investment
solutions to fulfill specific portfolio requirements.
Legg Mason
7
Total AUM by Product
Global Equities—37%
Customized Solutions—36%
U.S. Equities—27%
Customized solutions and
global quantitative equities
Innovative solutions within a quantitative
framework. The firm takes a consultative
approach to global asset management, and
applies complementary behavioral and
fundamental market insights to manage
portfolios with a repeatable, risk-aware process.
Small-cap equity
Known for its disciplined, value-oriented
approach to managing small caps. An asset
class pioneer, the firm’s founder is one of
the longest-tenured active managers.
Total Invested Assets
by Geography
U.S. Equity—83%
Rest of the World Equity—9%
European Equity—3%
Cash—5%
Fixed income
One of the world’s leading global fixed-
income managers. Founded in 1971,
the firm is known for team management,
proprietary research and a long-term
fundamental value approach.
8
Legg Mason
Total AUM by Mandate
Specialized—44%
(Corporate, Emerging Markets,
Long Duration, Global Portfolio,
Inflation-Linked)
Broad Portfolio—21%
Taxable Liquidity—32%
Municipals—3%
Legg Mason acquired QS Investors, a research-driven solutions asset manager, in a transaction that closed
on May 30th of 2014. Through QS, we have acquired a globally recognized manager with a distinctive and
differentiated investment process, noted solutions capabilities and a proprietary investment platform capable
of accommodating significant scale.
There are unique, complementary synergies among QS Investors, Batterymarch and LMGAA, and as previously
announced, Batterymarch and LMGAA will be combined over time with QS Investors to create a world-class
platform with unique solutions, quantitative equity and multi-manager asset allocation capabilities. The combined
platform will be branded under the QS Investors name and headed by QS Investors’ CEO Janet Campagna.
Building a scalable, global solutions platform that can both compete for and win large-scale institutional custom
solutions mandates, and bringing these solutions to the retail marketplace, has been one of our top priorities, and
we are very pleased to have taken this strong step forward.
For more than 40 years, Royce & Associates has utilized a disciplined, value-oriented approach in managing
small-cap and other equity portfolios. Known through The Royce Funds, its family of open-end mutual funds,
Royce is committed to the same investment principles that have served it well since 1972.
2013 was an exciting year for The Royce Funds. In April, Royce relaunched roycefunds.com to build a simpler, better
organized site that’s more vibrant and user-friendly, one that showcases our best asset—our experienced and
talented investment staff. The site uses a responsive design to ensure a consistent experience for someone who may
start viewing the website in the office on a desktop and continue on a tablet or mobile device on their way home.
The website was recognized by strategic consulting firm Kasina as one of the “10 best advisor websites,” based
on availability of content, quality of content and user experience. We were very pleased that the site also received
four Mutual Fund Education Alliance awards, including the Overall/Digital/Technology award.
In December, Chris Clark and Francis Gannon were named Co-Chief Investment Officers, a change that became
official on January 1, 2014. In their new roles they will provide supervision of Royce’s portfolio management
practice. This will encompass appropriate risk management oversight, as well as ensuring portfolio
accountability and compliance.
While Western Asset’s investment process remained unchanged in the year, we continued to reinvest in our
franchise and build out our investment resources. Our success has always been grounded in a steady focus on
our investment philosophy and process, and a commitment to hiring exceptional talent—our CIO, Ken Leech,
co-served with Steve Walsh last year in preparation for Steve’s retirement. Ken officially took over on March 31.
In the fiscal year and continuing into this year, we have increased our focus on higher-yielding investment
solutions in this low interest rate environment, and to unconstrained investing. These areas, specifically,
present very attractive global investment opportunities for our clients in an otherwise uncertain environment.
Western Asset earned several honors last year, including awards for Core and Core Plus from Institutional Investor,
for the Western Asset High Income Fund and the Global Corporate Bond Fund from Lipper, and for the Legg Mason
Western Asset U.S. High Yield Fund from Benchmark Magazine.
Legg Mason
9
GLOBAL DISTRIBUTION
LEGG MASON’S GLOBAL DISTRIBUTION BUSINESS TODAY
$252B in AUM globally
Over 200 client-facing team members
around the world
Gross FY 2014 sales of $65 billion, up
15% from FY 2013
Over 16 distribution offices in six regions
Serving more than 100,000 intermediary
clients globally
Four core themes, all around understanding and meeting
client needs, guide the management of Legg Mason’s
distribution platform:
1. Client solutions orientation: Drives how we think
about product development, how we cover the
intermediary channel and how we help intermediaries
serve investors.
2. Data-based decisions: Analysis of client, market
and demographic data informs our approach to client
segmentation and underpins our coverage model for
serving distribution partners and clients.
3. Broad global footprint: Investment and client service
teams around the world allow us to leverage and syndicate
the best ideas and practices, regardless of their origin.
4. Active partnership with Affiliate managers: We
collaborate with our asset managers throughout the sales
process with transparency and accountability and utilize
their expertise to most effectively serve our clients.
Global Distribution Sales leadership
10Legg Mason U.S. Distribution Sales team meeting
INVESTING IN INNOVATION FOR THE FUTURE
Industry research suggests that a new breed of asset
manager will emerge by 2020, with highly streamlined
platforms, targeted solutions and stronger brands.
Connecting with clients in a variety of ways to solve their
investment needs will be a continually evolving process.
At Legg Mason, we believe the smart players will find
new, innovative ways to harness customer and related
data available to better anticipate and serve our clients.
We will continue to evolve the traditional model to achieve
greater efficiency and effectiveness in distribution.
We want to deepen and expand client coverage and
improve the customer experience and salesforce
effectiveness through technology, marketing and training.
In the fiscal year, Legg Mason introduced a new solutions-
oriented, capital markets-based selling approach and a
modified sales compensation plan to reinforce it.
We’ve segmented the business needs of advisors that we
believe represent our opportunity set, including those we
work with today as well as those whom we have identified
as having great potential for us.
We drew inspiration from the meaningful success we’ve had
with our innovative cross channel team, which we launched
in 2011. As a result, our conviction is high that multiple
coverage models can lift the productivity of all sales teams
and create a more powerful distribution system.
Starting in fiscal year 2015, we are meaningfully expanding
client-facing teams, with a particular focus on channels in
which we have both established a strong track record and
see meaningful growth opportunities. These investments
are being amplified.
Global
Investment
Survey
Legg Mason’s survey is an
annual vehicle in which
we connect with investors
in all of the regions in
which we operate. Our 2014
survey interviews over
4,000 affluent investors from more than 20 countries to find
out their views on current asset allocations versus their goals,
and their perceptions of opportunities across asset classes
and geographies.
The findings from the survey provide valuable perspectives as
we think about product development in the context of solving
the investment challenges investors face. We use the data we
collect to educate our sales teams and our distribution partners,
and to build our brand with investors around the globe.
11Legg Mason CORPORATE CITIZENSHIP
INVESTING IN
OUR COMMUNITIES
The primary focus of the Legg Mason Charitable Foundation
is on education, especially as it relates to at-risk children in
the areas in which Legg Mason employees live and work.
We believe that our foundation contributions will yield the
most results when we partner with grassroots organizations
with strong local presences. More importantly, we take an
integrated approach: applying both our financial resources
and our employee time and effort with our Tier One
Partners in the community.
Our partners directly meet one of our stated objectives;
they are at a size in which Legg Mason’s commitment really
makes a difference; and they generally have Board support
from one or more Legg Mason employees.
Our objectives focus on the following needs:
• Strong and innovative principals
• Well-trained teachers with appropriate resources
• Funding high-quality early education and after-
school programs
• Scholarship funding for at-risk children
We rolled out this focused investment in community
partners last year in Baltimore at Saint Ignatius Loyola.
We are in the process of implementing similar partnerships
at local organizations in metro areas in which we have a
strong employee presence.
Saint Ignatius Loyola Academy is a tuition-free,
independent Jesuit school for underserved boys in
grades six through eight. The Academy has a 20-year
history of providing quality education to at-risk children,
of diverse races, ethnicities and religions, who live in
Baltimore. Enrollment in the Academy is determined by a
variety of factors, including financial need, a demonstrated
desire to succeed and residence in Baltimore City.
Legg Mason’s financial contribution supports scholarships
for students and new building renovations at the school’s
campus. Our employees volunteer at the school with the
students and provide skill-based volunteering to support
the school’s infrastructure. Legg Mason professionals are
currently helping to relaunch the school’s website. And,
there are fundraising opportunities throughout the year to
engage employee interest.
Measuring Successful Partners
98% of Saint Ignatius Loyola Academy graduates receive a high school diploma.
88% of Academy graduates matriculate at post-secondary educational institutions.
12Legg Mason SUSTAINABILITY STANDARDS
ENVIRONMENTAL, SOCIAL
AND GOVERNANCE FACTORS
Institutional investors and consultants increasingly
understand the relevance of environmental, social and
governance (ESG) factors to well-run companies and to
the long-term health and stability of the markets.
At Legg Mason, our investment managers have long
considered that sustainability is part of the long-term health
of businesses and the markets in which they function.
Approximately 13% of our total long-term AUM is in
ESG/socially responsible investing strategies, and as
consultants, pensions, foundations and endowments
increasingly look at these factors when making investment
decisions, we expect this area to grow.
In fact, our largest equity Affiliate, ClearBridge
Investments, believes that the integration of ESG factors
into its fundamental research and stock selection process
is a compelling offering. Governance issues are another
important component of its engagement and advocacy
work, as an integral part of its long-term view of stock
ownership. ClearBridge has offered active ESG strategies
for clients since 1987.
As long-term investors, responsible stewardship of our
investments is an important consideration. We firmly
believe that the companies that are thoughtful about these
issues are often well-run companies.
And, at Legg Mason, we seek to run our business in
the same way. Over the past several years, we have
sought to both increase our efficiency in operations and
reduce greenhouse gas emissions. We have done this
through consolidating in energy-efficient buildings,
investing in teleconferencing technology, outsourcing
data centers and utilizing cloud technology. The space
in Legg Mason’s headquarters has obtained LEED gold
certification. Collectively, these actions allow us both to
run our business more efficiently and to have a positive
long-term impact on the environment.
Legg Mason benchmarks its efforts against standards
set by leading ESG organizations.
In partnership with sustainability advocate Ceres, we
engage with our stakeholders on an ongoing basis regarding
our sustainability efforts and reporting to take advantage
of diverse perspectives on our progress. The Carbon
Disclosure Project named
Legg Mason to the
2013 Climate Disclosure
Leadership Index (CDLI)
in recognition of the firm’s
energy use reporting.
We believe that reflecting corporate environmental factors
in business planning has a positive impact on mitigating
climate-related risks and strengthens our business.
Legg Mason’s Sustainability Council, led by Investor
Relations, is focused on education and awareness,
operations and efficiency, and carbon reporting and
data collection.
In 2013, Legg Mason and its investment Affiliates, in
partnership with Mercer Consulting, hosted a “Responsible
Investing Teach-In” that included investment professionals
and shared services employees from multiple corporate
and Affiliate campuses.
2013 Corporate
& Social
Responsibility
Report
We published our most
recent Corporate & Social
Responsibility Report earlier
this year, which covered calendar year 2013.
The report provides an update to our many stakeholders
on the programs and activities we offer in all areas of
sustainability: the environment, diversity, volunteerism,
community and philanthropy, with a focus on environmental
issues and initiatives.
Among key achievements noted in the report was our
inclusion in the prestigious 2013 Climate Disclosure
Leadership Index, which required a score within the top
10% of S&P 500 companies that submitted a CDP response.
Legg Mason ranked ninth out of 55 financial services
companies that responded.
13Legg Mason BOARD OF DIRECTORS
Standing left to right
Seated left to right
John E. Koerner III
Managing Member, Koerner Capital, LLC
W. Allen Reed
Private Investor; Retired CEO,
GM Asset Management Corporation
(Chairman of the Finance Committee)
Kurt L. Schmoke
President-elect of the
University of Baltimore;
Former Mayor of Baltimore
Dennis M. Kass
Private Investor; Retired CEO,
Jennison Associates
(Chairman of the Board)
Joseph A. Sullivan
President and CEO, Legg Mason, Inc.
John H. Myers
Senior Advisor, Angelo, Gordon & Co.;
Retired President and CEO,
GE Asset Management (GEAM)
Cheryl Gordon Krongard
Private Investor; Former CEO,
Rothschild Asset Management
(Chairman of the
Compensation Committee)
John V. Murphy
Retired Chairman and CEO,
OppenheimerFunds
Barry W. Huff
Retired Vice Chairman, Deloitte
(Chairman of the Audit Committee)
Nelson Peltz
CEO and Founding Partner,
Trian Fund Management, L.P.
(Chairman of the Nominating &
Corporate Governance Committee)
John T. Cahill
Executive Chairman,
Kraft Foods Group, Inc.
Margaret Milner Richardson
Private Consultant and Investor;
Former U.S. Commissioner
of Internal Revenue
Harold L. Adams
Chairman Emeritus,
RTKL Associates, Inc.
Robert E. Angelica
Private Investor; Former Chairman
and CEO, AT&T Investment
Management Corporation
(Chairman of the Risk Committee)
Not pictured
Carol Anthony (“John”) Davidson
Retired Senior Vice President,
Controller and Chief Accounting Officer,
Tyco International
Our New Director
Carol Anthony (“John”) Davidson
is retired senior vice president,
controller and chief accounting
officer of Tyco International, where
he was responsible for overseeing
financial reporting, internal controls
and accounting policy across Tyco’s
global operations.
Prior to joining Tyco in January
2004, Mr. Davidson served as vice
president, audit, risk and compliance
for Dell Inc. During his six-year career
at Dell, he served in other senior
capacities, including chief compliance
officer, vice president and corporate
controller, and vice president of
internal audit.
Mr. Davidson is a member of
the board of directors of DaVita
HealthCare Partners Inc. and
Pentair Ltd. His other affiliations
include membership on the board of
trustees of the Financial Accounting
Foundation and the board of
governors of the Financial Industry
Regulatory Authority.
14Legg Mason Selected Financial Data
(Dollars in thousands, except per share amounts or unless otherwise noted)
OPERATING RESULTS
Operating Revenues
2014
2013
2012
2011
2010
Years Ended March 31,
$2,741,757
$2,612,650
$2,662,574
$2,784,317
$2,634,879
Operating expenses, excluding impairment
2,310,864
2,313,149
2,323,821
2,397,509
2,313,696
Impairment of intangible assets and goodwill
Operating Income (Loss)
Other non-operating expense, net
Other non-operating income (loss) of consolidated
investment vehicles, net
Fund support
Income (Loss) before Income Tax Provision (Benefit)
Income tax provision (benefit)
Net Income (Loss)
Less: Net income (loss) attributable to
noncontrolling interests
—
430,893
(13,726)
2,474
—
419,641
137,805
281,836
734,000
(434,499)
(73,287)
—
338,753
(54,006)
—
386,808
(23,315)
—
321,183
(32,027)
(2,821)
18,336
1,704
17,329
—
(510,607)
(150,859)
(359,748)
—
303,083
72,052
231,031
—
365,197
119,434
245,763
23,171
329,656
118,676
210,980
(2,948)
(6,421)
10,214
(8,160)
6,623
Net Income (Loss) Attributable to Legg Mason, Inc.
$ 284,784
$ (353,327)
$ 220,817
$ 253,923
$ 204,357
PER SHARE
Net Income (Loss) per Share Attributable to
Legg Mason, Inc. Common Shareholders:
Basic
Diluted
Weighted-Average Shares Outstanding:
Basic
Diluted(1)
Dividends Declared
BALANCE SHEET
Total Assets
Long-term debt
Total Stockholders’ Equity
FINANCIAL RATIOS AND OTHER DATA
Adjusted Income(2)
Adjusted Income per diluted share(2)
Operating Margin
Operating Margin, as Adjusted(3)
Total debt to total capital(4)
Assets under management (in millions)
Full-time employees
$ 2.34
$ (2.65)
$ 1.54
$ 1.63
$ 1.33
$ 2.33
$ (2.65)
$ 1.54
$ 1.63
$ 1.32
121,941
122,383
133,226
133,226
143,292
143,349
155,321
155,484
153,715
155,362
$ 0.52
$ 0.44
$ 0.32
$ 0.20
$ 0.12
$7,111,349
$ 7,269,660
$8,555,747
$ 8,707,756
$8,622,632
1,039,264
4,724,724
1,144,954
4,818,351
1,136,892
5,677,291
1,201,868
5,770,384
1,170,334
5,841,724
$ 417,805
$ 347,169
$ 397,030
$ 439,248
$ 381,258
$ 3.41
$ 2.61
$ 2.77
$ 2.83
$ 2.45
15.7%
22.0%
18.0%
(16.6)%
17.5%
19.2%
12.7%
22.3%
19.6%
13.9%
24.3%
20.1%
12.2%
21.9%
19.6%
$ 701,774
$ 664,609
$ 643,318
$ 677,646
$ 684,549
2,843
2,975
2,979
3,395
3,550
(1) Basic shares and diluted shares are the same for periods with a net loss.
(2) Adjusted Income is a non-GAAP performance measure. We define Adjusted Income as Net Income (Loss) Attributable to Legg Mason, Inc., plus amortiza-
tion and deferred taxes related to intangible assets and goodwill, and imputed interest and tax benefits on contingent convertible debt less deferred income
taxes on goodwill and indefinite-life intangible asset impairment, if any. We also adjust for certain non-core items, such as intangible asset impairments,
the impact of fair value adjustments of contingent consideration liabilities, if any, the impact of tax rate adjustments on certain deferred tax liabilities related
to indefinite-life intangible assets, and loss on extinguishment of contingent convertible debt. See Supplemental Non-GAAP Information in Management’s
Discussion and Analysis of Financial Condition and Results of Operations.
(3) Operating Margin, as Adjusted, is a non-GAAP performance measure we calculate by dividing (i) Operating Income (Loss), adjusted to exclude the impact
on compensation expense of gains or losses on investments made to fund deferred compensation plans, the impact on compensation expense of gains or
losses on seed capital investments by our affiliates under revenue sharing agreements, amortization related to intangible assets, transition-related costs of
streamlining our business model, if any, income (loss) of consolidated investment vehicles, the impact of fair value adjustments of contingent consideration
liabilities, if any, and impairment charges by (ii) our Operating Revenues, adjusted to add back net investment advisory fees eliminated upon consolidation of
investment vehicles, less distribution and servicing expenses which we use as an approximate measure of revenues that are passed through to third parties,
which we refer to as “Operating Revenues, as Adjusted.” See Supplemental Non-GAAP Information in Management’s Discussion and Analysis of Financial
Condition and Results of Operations.
(4) Calculated based on total debt as a percentage of total capital (total stockholders’ equity plus total debt) as of March 31.
15
Legg Mason Management’s Discussion and Analysis of Financial Condition
and Results of Operations
EXECUTIVE OVERVIEW
Legg Mason, Inc., a holding company, with its subsidiaries
(which collectively comprise “Legg Mason”) is a global
asset management firm. Acting through our subsidiaries,
we provide investment management and related services
to institutional and individual clients, company-sponsored
mutual funds and other investment vehicles. We offer
these products and services directly and through various
financial intermediaries. We have operations principally
in the United States of America (“U.S.”) and the United
Kingdom (“U.K.”) and also have offices in Australia,
Bahamas, Brazil, Canada, Chile, China, Dubai, France,
Germany, Italy, Japan, Luxembourg, Poland, Singapore,
Spain, Switzerland and Taiwan. All references to fiscal
2014, 2013 or 2012, refer to our fiscal year ended March
31 of that year. Terms such as “we,” “us,” “our,” and
“Company” refer to Legg Mason.
Our operating revenues primarily consist of investment
advisory fees from separate accounts and funds, and
distribution and service fees. Investment advisory fees
are generally calculated as a percentage of the assets of
the investment portfolios that we manage. In addition,
performance fees may be earned under certain investment
advisory contracts for exceeding performance benchmarks.
The largest portion of our performance fees is earned
based on 12-month performance periods that end in
differing quarters during the year, with a portion based on
quarterly performance periods. Distribution and service
fees are received for distributing investment products
and services, or for providing other support services to
investment portfolios, and are generally calculated as a
percentage of the assets in an investment portfolio or
as a percentage of new assets added to an investment
portfolio. Our revenues, therefore, are dependent upon the
level of our assets under management (“AUM”) and fee
rates, and thus are affected by factors such as securities
market conditions, our ability to attract and maintain
AUM and key investment personnel, and investment
performance. Our AUM primarily vary from period to
period due to inflows and outflows of client assets as
well as market performance. Client decisions to increase
or decrease their assets under our management, and
decisions by potential clients to utilize our services, may
be based on one or more of a number of factors. These
factors include our reputation in the marketplace, the
investment performance (both absolute and relative to
benchmarks or competitive products) of our products
and services, the fees we charge for our investment
services, the client or potential client’s situation, including
investment objectives, liquidity needs, investment horizon
and amount of assets managed, our relationships with
distributors and the external economic environment,
including market conditions.
The fees that we charge for our investment services
vary based upon factors such as the type of underlying
investment product, the amount of AUM, the asset
management affiliate that provides the services, and
the type of services (and investment objectives) that are
provided. Fees charged for equity asset management
services are generally higher than fees charged for
fixed income and liquidity asset management services.
Accordingly, our revenues and average advisory revenue
yields will be affected by the composition of our AUM,
with changes in the relative level of equity assets more
significantly impacting our revenues and average advisory
revenue yields. Average advisory revenue yields are
calculated as the ratio of annualized investment advisory
fees, excluding performance fees, to average AUM.
In addition, in the ordinary course of our business, we
may reduce or waive investment management fees, or
limit total expenses, on certain products or services for
particular time periods to manage fund expenses, or for
other reasons, and to help retain or increase managed
assets. We have revenue sharing agreements in place
with most of our asset management affiliates, under
which specified percentages of the affiliates’ revenues
are required to be distributed to us and the balance of the
revenues is retained to pay operating expenses, including
compensation expenses, but excluding certain expenses
and income taxes. Under these agreements, our asset
management affiliates retain different percentages of
revenues to cover their costs. As such, our Net Income
(Loss) Attributable to Legg Mason, Inc., operating margin
and compensation as a percentage of operating revenues
are impacted based on which affiliates generate our
revenues, and a change in AUM at one affiliate can have a
dramatically different effect on our revenues and earnings
than an equal change at another affiliate. In addition,
from time to time, we may agree to changes in revenue
sharing agreements and other arrangements with our
asset management personnel, which may impact our
compensation expenses and profitability.
The most significant component of our cost structure
is employee compensation and benefits, of which a
majority is variable in nature and includes incentive
compensation that is primarily based upon revenue levels,
non-compensation related operating expense levels at
revenue share-based affiliates, and our overall profitability.
The next largest component of our cost structure is
distribution and servicing expense, which consists
primarily of fees paid to third-party distributors for selling
our asset management products and services and are
largely variable in nature. Certain other operating costs are
quasi-fixed in nature, such as occupancy, depreciation and
amortization, and fixed contract commitments for market
data, communication and technology services, and usually
16
Legg Mason do not decline with reduced levels of business activity
or, conversely, usually do not rise proportionately with
increased business activity.
retaining clients. In the last few years, the industry has
seen flows into products for which we do not currently
garner significant market share.
Our financial position and results of operations are
materially affected by the overall trends and conditions
of the financial markets, particularly in the U.S., but
increasingly in the other countries in which we operate.
Results of any individual period should not be considered
representative of future results. Our profitability is
sensitive to a variety of factors, including the amount and
composition of our AUM, and the volatility and general
level of securities prices and interest rates, among other
things. Periods of unfavorable market conditions are likely
to have an adverse effect on our profitability. In addition,
the diversification of services and products offered,
investment performance, access to distribution channels,
reputation in the market, attracting and retaining key
employees and client relations are significant factors in
determining whether we are successful in attracting and
The financial services business in which we are engaged
is extremely competitive. Our competition includes
numerous global, national, regional and local asset
management firms, broker-dealers, commercial banks and
other financial services companies. The industry has been
impacted by continued economic uncertainty, the constant
introduction of new products and services, and the
consolidation of financial services firms through mergers
and acquisitions. The industry in which we operate is also
subject to extensive regulation under federal, state, and
foreign laws. Like most firms, we have been impacted by
regulatory and legislative changes. Responding to these
changes and keeping abreast of regulatory developments,
has required, and will continue to require, us to incur costs
that continue to impact our profitability.
Our strategic priorities are focused on four primary areas listed below. Management keeps these strategic priorities in
mind when it evaluates our operating performance and financial condition. Consistent with this approach, we have also
presented in the table below the most important initiatives on which management currently focuses in evaluating our
performance and financial condition.
Strategic Priorities
Initiatives
Products
• Create an innovative portfolio of investment products and promote revenue growth through new product
development and leveraging the capabilities of our affiliates
• Identify and execute strategic acquisitions to increase product offerings and fill gaps in products
and services
Performance
• Deliver compelling and consistent performance against both relevant benchmarks and the products and
Distribution
Productivity
services of our competitors
• Evaluate and reallocate resources within and to our distribution platform to continue to maintain and
enhance our top tier distribution function with the capability to offer solutions to relevant investment
challenges and grow market share worldwide
• Operate with a high level of effectiveness and improve ongoing efficiency
• Manage expenses
• Align affiliate economic relationships
The strategic priorities discussed above are designed to
drive improvements in our operating margin, net flows,
earnings, cash flows, assets under management and other
key metrics. Certain of these key metrics are discussed in
our annual results discussion to follow. In connection with
these strategic priorities, during the year ended March 31,
2014, we incurred $29.4 million in expenses related to
various corporate initiatives, including the closing down or
reorganizing of certain businesses and ongoing efforts to
increase efficiency and effectiveness. Beginning in fiscal
2015, we plan to invest in our centralized global
distribution business, which will include the reinvestment
of savings from these various corporate initiatives.
In March 2014, we entered into an agreement to acquire
QS Investors Holdings, LLC (“QS Investors”), a leading
customized solutions and global quantitative equities
provider with approximately $5 billion in AUM and nearly
$100 billion in assets under advisement (“AUA”) as of
March 31, 2014. This acquisition is expected to close in
the first quarter of fiscal 2015. In connection with the
completion of this acquisition, beginning in the first quarter
of fiscal 2015, we will begin reporting AUA. Two of our
existing affiliates, Batterymarch Financial Management,
Inc. (“Batterymarch”) and Legg Mason Global Asset
Allocation, LLC (“LMGAA”), will be integrated over time
into QS Investors to leverage the best aspects of each
17
Legg Mason subsidiary. In connection with the integration, we expect
to incur restructuring and transition costs of approximately
$35 million, approximately $2.5 million of which was
incurred in the year ended March 31, 2014. Approximately
$30 million of the anticipated remaining costs associated
with the integration are expected to be incurred in the year
ending March 31, 2015.
Net Income Attributable to Legg Mason, Inc. for fiscal
2014 was $284.8 million, or $2.33 per diluted share, as
compared to Net Loss Attributable to Legg Mason, Inc. of
$353.3 million, or $2.65 per diluted share, for fiscal 2013.
The prior year loss was primarily attributable to $734.0
million, or $3.81 per diluted share, of non-cash impairment
charges related to intangible assets and a $69.0 million,
or $0.34 per diluted share, non-operating charge from
the extinguishment of debt. Average AUM, and total
revenues, increased in fiscal 2014, as compared to fiscal
2013. Strong overall investment performance and the
improvement of our global distribution function contributed
to a continued reduction in long-term asset outflows.
Increases in AUM due to market performance and new
product launches in fiscal 2014, offset modest outflows in
long-term assets.
The following discussion and analysis provides additional
information regarding our financial condition and results
of operations.
BUSINESS ENVIRONMENT AND
RESULTS OF OPERATIONS
The business environment in fiscal 2014 was marked by a
slow, steady growth in the U.S. economy. The economy
experienced steady growth despite a broad range of
mixed economic news including improvements in the
housing sector and consumer confidence and uncertainty
regarding the Federal Reserve’s bond buying program. All
three major U.S. equity market indices increased during
fiscal 2014 while two of the major U.S. equity market
indices reached record highs during the final quarter of
fiscal 2014. The fixed income markets experienced a
more difficult year as longer-term market interest rates
increased, due in part to the Federal Reserve tapering
its bond buying program. While the economic outlook
has remained more positive than in recent years, the
financial environment in which we operate still reflects a
heightened level of sensitivity as we move into fiscal 2015.
All three major U.S. equity market indices and the Barclays Capital Global Aggregate Bond Index increased during the
past three fiscal years, while the Barclays Capital U.S. Aggregate Bond Index was slightly negative in fiscal 2014, after
increasing during fiscal 2012 and 2013, as illustrated in the table below:
Indices(1)
Dow Jones Industrial Average
S&P 500
NASDAQ Composite Index
Barclays Capital U.S. Aggregate Bond Index
Barclays Capital Global Aggregate Bond Index
% Change for the Year Ended March 31,
2014
12.9%
19.3%
28.5%
(0.1)%
1.9%
2013
10.3%
11.4%
5.7%
3.8%
1.3%
2012
7.2%
6.2%
11.2%
7.7%
5.3%
(1) Indices are trademarks of Dow Jones & Company, McGraw-Hill Companies, Inc., NASDAQ Stock Market, Inc., and Barclays Capital, respectively, which are not
affiliated with Legg Mason.
18
Legg Mason The following table sets forth, for the periods indicated, amounts in the Consolidated Statements of Income (Loss) as a
percentage of operating revenues and the increase (decrease) by item as a percentage of the amount for the previous period:
Percentage of Operating Revenues
Period to Period Change(1)
Years Ended March 31,
2014
2013
2012
2014
Compared
to 2013
2013
Compared
to 2012
28.4%
28.0%
29.1%
6.4%
(5.8)%
Operating Revenues
Investment advisory fees
Separate accounts
Funds
Performance fees
Distribution and service fees
Other
Total Operating Revenues
Operating Expenses
Compensation and benefits
Transition-related compensation
Total Compensation and Benefits
Distribution and servicing
Communications and technology
Occupancy
Amortization of intangible assets
Impairment of intangible assets
Other
Total Operating Expenses
Operating Income (Loss)
Other Non-Operating Income (Expense)
Interest income
Interest expense
Other income (expense), net
Other non-operating income (expense) of consolidated
investment vehicles, net
Total other non-operating expense
Income (Loss) before Income Tax Provision (Benefit)
Income tax provision (benefit)
Net Income (Loss)
Less: Net income (loss) attributable to
noncontrolling interests
54.7
3.9
12.7
0.3
55.3
3.8
12.6
0.3
56.0
1.9
12.8
0.2
100.0
100.0
100.0
44.1
—
44.1
22.6
5.8
4.2
0.4
—
7.2
84.3
15.7
0.2
(1.9)
1.2
0.1
(0.4)
15.3
5.0
10.3
(0.1)
45.5
—
45.5
23.0
5.7
6.6
0.5
28.1
7.2
116.6
(16.6)
0.3
(2.4)
(0.7)
(0.1)
(2.9)
(19.5)
(5.7)
(13.8)
(0.3)
41.7
1.3
43.0
24.4
6.2
5.8
0.7
—
7.2
87.3
12.7
0.4
(3.3)
0.8
0.8
(1.3)
11.4
2.7
8.7
0.4
Net Income (Loss) Attributable to Legg Mason, Inc.
10.4%
(13.5)%
8.3%
n/m—not meaningful
(1) Calculated based on the change in actual amounts between fiscal years as a percentage of the prior year amount.
3.8
8.6
5.2
16.7
4.9
1.8
n/m
1.8
3.1
5.5
(33.0)
(12.1)
n/m
4.0
(24.2)
n/m
(15.8)
(15.9)
n/m
n/m
(85.2)
n/m
n/m
n/m
(54.1)
n/m
(3.0)
99.2
(3.1)
35.8
(1.9)
7.1
n/m
3.9
(7.6)
(9.1)
11.0
(28.6)
n/m
(1.2)
31.1
n/m
(33.9)
(28.2)
n/m
n/m
n/m
n/m
n/m
n/m
n/m
n/m
19
Legg Mason ASSETS UNDER MANAGEMENT
Our AUM is primarily managed across the following asset classes:
Equity
Fixed Income
• Large Cap Growth
• Small Cap Core
• Large Cap Value
• Equity Income
• Global Equity
• Sector Equity
• International Equity
• Mid Cap Core
• Global Emerging Market Equity
• U.S. Intermediate Investment Grade
• Global Government
• U.S. Credit Aggregate
• Global Opportunistic Fixed Income
• U.S. Municipal
• Global Fixed Income
• U.S. Long Duration
• U.S. Limited Duration
• U.S. High Yield
• Emerging Markets
Liquidity
• U.S. Managed Cash
• U.S. Municipal Cash
The components of the changes in our AUM (in billions)
for the years ended March 31, were as follows:
Beginning of period
$664.6
$643.3
$677.6
2014
2013
2012
Investment funds, excluding
liquidity funds(1)
Subscriptions
Redemptions
Separate account flows, net
Liquidity fund flows, net
Net client cash flows
Market performance and other(2)
52.1
44.9
46.9
(58.1)
(49.0)
(51.1)
2.5
11.8
8.3
30.2
(27.4)
(35.9)
19.8
12.6
(11.7)
(27.5)
34.2
17.1
Acquisitions (dispositions), net
(1.3)
(1.2)
(23.9)
End of period
$701.8
$664.6
$643.3
(1) Subscriptions and redemptions reflect the gross activity in the funds and
include assets transferred between funds and between share classes.
(2) Includes the negative impact of foreign exchange movements, primarily
on fixed income securities, of $4.9 billion, $8.3 billion, and $1.8 billion
for the years ended March 31, 2014, 2013 and 2012, respectively. Also
includes reinvestment of dividends and other.
AUM at March 31, 2014 was $701.8 billion, an increase of
$37.2 billion, or 6%, from March 31, 2013. The increase
in AUM was attributable to net client inflows of $8.3
billion and market performance and other of $30.2 billion,
partially offset by the disposition of $1.3 billion resulting
from the sale of a small affiliate. Market performance and
other includes $4.9 million resulting from the negative
impact of foreign currency exchange fluctuations. There
were $12.1 billion of net client inflows into the liquidity
asset class and $3.8 billion of net outflows from long-
term asset classes. Equity outflows of $5.0 billion
were partially offset by fixed income inflows of $1.2
billion. Equity outflows occurred in products managed
at Royce & Associates (“Royce”), Batterymarch, The
Permal Group, Ltd. (“Permal”), and ClearBridge, LLC,
formerly Legg Mason Capital Management (“LMCM”),
and were partially offset by equity inflows at ClearBridge
Investments, LLC (“ClearBridge”). Due in part to product
investment performance, we have experienced net annual
outflows in our equity asset class since fiscal 2007. Fixed
income inflows were primarily in products managed
by Brandywine Global Investment Management, LLC
(“Brandywine”), and were partially offset by outflows
principally at Western Asset Management Company
(“Western Asset”), including $4.8 billion in outflows from
a single, low-fee global sovereign mandate managed
by Western Asset. As previously discussed, in the first
quarter of fiscal 2015, we will begin reporting AUA, which
will primarily be related to QS Investors. In addition,
approximately $13 billion of fixed income assets classified
as AUM as of March 31, 2014 will be reclassified to AUA in
the first quarter of fiscal 2015, including the assets related
to this low-fee global sovereign mandate. We experienced
net fixed income inflows in fiscal 2014, after experiencing
net fixed income outflows during the prior five fiscal years.
We generally earn higher fees and profits on equity AUM,
and outflows in the equity asset class will more negatively
impact our revenues and Net Income (Loss) Attributable
to Legg Mason, Inc. than would outflows in other asset
classes. During the month ended April 30, 2014, we
experienced liquidity outflows of approximately $20 billion,
primarily from a low-fee money market fund. We do not
expect this outflow to have a material impact on our
revenues or net income.
AUM at March 31, 2013, was $664.6 billion, an increase
of $21.3 billion, or 3%, from March 31, 2012. The increase
in AUM was attributable to market performance and other
of $34.2 billion and $5.4 billion related to the acquisition
of Fauchier Partners Management Limited (“Fauchier”).
Market performance and other includes $8.3 billion
20
Legg Mason resulting from the negative impact of foreign currency
exchange fluctuations. These increases were offset in
part by net client outflows of $11.7 billion and dispositions
of $6.6 billion. The dispositions were in liquidity assets
which resulted from the amendment of historical Smith
Barney brokerage programs providing for investment in
liquidity funds that our asset managers manage. Long-
term asset classes accounted for the net client outflows,
with $20.4 billion and $11.0 billion in equity and fixed
income outflows, respectively, partially offset by liquidity
inflows of $19.7 billion. Equity outflows were primarily
experienced by products managed at Batterymarch,
Royce, Permal, and LMCM. The majority of fixed income
outflows were in products managed by Western Asset,
including $6.4 billion in outflows from the low-fee global
sovereign mandate discussed above. Fixed income
outflows at Western Asset were offset in part by fixed
income inflows at Brandywine.
Our investment advisory and administrative contracts are
generally terminable at will or upon relatively short notice,
and investors in the mutual funds that we manage may
redeem their investments in the funds at any time without
prior notice. Institutional and individual clients can terminate
their relationships with us, reduce the aggregate amount
of assets under management, or shift their funds to other
types of accounts with different rate structures for any
number of reasons, including investment performance,
changes in prevailing interest rates, changes in our
reputation in the marketplace, changes in management or
control of clients or third-party distributors with whom we
have relationships, loss of key investment management
personnel or financial market performance.
AUM by Asset Class
AUM by asset class (in billions) for the years ended March 31 were as follows:
Equity
Fixed Income
Liquidity
Total
2014
% of Total
2013
% of Total
2012
% of Total
$186.4
365.2
150.2
27%
$161.8
24%
$163.4
52
21
365.1
137.7
55
21
356.1
123.8
26%
55
19
$701.8
100%
$664.6
100%
$643.3
100%
Average AUM by asset class (in billions) for the years ended March 31 were as follows:
Equity
Fixed Income
Liquidity
Total
2014
% of Total
2013
% of Total
2012
% of Total
$172.8
358.7
135.9
$667.4
26%
$152.1
24%
$168.4
54
20
364.5
128.9
56
20
359.8
116.6
26%
56
18
100%
$645.5
100%
$644.8
100%
% Change
2014
Compared to
2013
2013
Compared to
2012
15%
—
9
6%
(1)%
3
11
3%
% Change
2014
Compared to
2013
2013
Compared to
2012
14%
(2)
5
3%
(10)%
1
11
—%
21
Legg Mason The component changes in our AUM by asset class (in billions) for the fiscal years ended March 31, 2014, 2013 and 2012,
were as follows:
Equity
$189.6
Fixed Income
Liquidity
$356.6
$131.4
Total
$677.6
21.7
(30.4)
(12.6)
—
(21.3)
(2.1)
(2.8)
25.2
(20.7)
(23.1)
—
(18.6)
19.3
(1.2)
163.4
356.1
18.9
(26.4)
(12.9)
—
(20.4)
13.4
5.4
26.0
(22.6)
(14.4)
—
(11.0)
20.0
—
—
—
(0.2)
12.6
12.4
(0.1)
(19.9)
123.8
—
—
(0.1)
19.8
19.7
0.8
(6.6)
46.9
(51.1)
(35.9)
12.6
(27.5)
17.1
(23.9)
643.3
44.9
(49.0)
(27.4)
19.8
(11.7)
34.2
(1.2)
161.8
365.1
137.7
664.6
27.0
(30.1)
(1.9)
—
(5.0)
30.9
(1.3)
25.1
(28.0)
4.1
—
1.2
(1.1)
—
—
—
0.3
11.8
12.1
0.4
—
52.1
(58.1)
2.5
11.8
8.3
30.2
(1.3)
$186.4
$365.2
$150.2
$701.8
March 31, 2011
Investment funds, excluding liquidity funds
Subscriptions
Redemptions
Separate account flows, net
Liquidity fund flows, net
Net client cash flows
Market performance and other
Acquisitions (dispositions), net
March 31, 2012
Investment funds, excluding liquidity funds
Subscriptions
Redemptions
Separate account flows, net
Liquidity fund flows, net
Net client cash flows
Market performance and other
Acquisitions (dispositions), net
March 31, 2013
Investment funds, excluding liquidity funds
Subscriptions
Redemptions
Separate account flows, net
Liquidity fund flows, net
Net client cash flows
Market performance and other
Acquisitions (dispositions), net
March 31, 2014
22
Legg Mason AUM by Distribution Channel
We have two principal distribution channels, Global
Distribution and Affiliate/Other, through which we
sell a variety of investment products and services.
Global Distribution, which consists of our centralized
global distribution operations, principally sells U.S.
and international mutual funds and other commingled
vehicles, retail separately managed account programs,
and sub-advisory accounts for insurance companies and
similar clients. Affiliate/Other consists of the distribution
operations within our asset managers which principally
sell institutional separate accounts and liquidity (money
market) funds.
The component changes in our AUM by distribution channel (in billions) for the years ended March 31, 2014, 2013 and
2012, were as follows:
March 31, 2011
Net client cash flows, excluding liquidity funds
Liquidity fund flows, net
Net client cash flows
Market performance and other
Acquisitions/(dispositions), net
March 31, 2012
Net client cash flows, excluding liquidity funds
Liquidity fund flows, net
Net client cash flows
Market performance and other
Acquisitions/(dispositions), net
March 31, 2013
Net client cash flows, excluding liquidity funds
Liquidity fund flows, net
Net client cash flows
Market performance and other
Acquisitions/(dispositions), net
March 31, 2014
Global
Distribution
Affiliate/Other
$220.3
$457.3
Total
$677.6
(2.3)
—
(2.3)
2.6
—
220.6
2.2
—
2.2
9.3
—
232.1
(1.2)
—
(1.2)
16.5
—
(37.8)
12.6
(25.2)
14.5
(23.9)
422.7
(33.7)
19.8
(13.9)
24.9
(1.2)
432.5
(2.3)
11.8
9.5
13.7
(1.3)
(40.1)
12.6
(27.5)
17.1
(23.9)
643.3
(31.5)
19.8
(11.7)
34.2
(1.2)
664.6
(3.5)
11.8
8.3
30.2
(1.3)
$247.4
$454.4
$701.8
Our overall effective fee rate across all asset classes
and distribution channels was 34 basis points for each
of the years ended March 31, 2014 and 2013, and was
35 basis points for the year ended March 31, 2012.
Fees for managing equity assets are generally higher,
averaging approximately 70 basis points for the year
ended March 31, 2014, and 75 basis points for each
of the years ended March 31, 2013 and 2012. This
compares to fees for managing fixed income assets,
which averaged approximately 25 basis points for each
of the years ended March 31, 2014, 2013 and 2012, and
liquidity assets, which averaged under 10 basis points
(reflecting the impact of current advisory fee waivers due
to the low interest rate environment) for each of the years
ended March 31, 2014, 2013 and 2012. Equity assets are
primarily managed by ClearBridge, Royce, Batterymarch,
and Permal; fixed income assets are primarily managed
by Western Asset, Brandywine, and Permal; and liquidity
assets are primarily managed by Western Asset. Fee
rates for assets distributed through Legg Mason Global
Distribution, which are predominately retail in nature,
averaged approximately 50 basis points for each of the
years ended March 31, 2014, 2013 and 2012, while fee
rates for assets distributed through the Affiliate/Other
channel averaged approximately 30 basis points for each
of the years ended March 31, 2014, 2013 and 2012.
23
Legg Mason Investment Performance
Overall investment performance of our AUM for the years
ended March 31, 2014, 2013 and 2012, was generally
positive compared to relevant benchmarks.
Year Ended March 31, 2014
For the year ended March 31, 2014, most U.S. indices
produced positive returns. The best performing was the
NASDAQ Composite, returning 28.5%. These returns
were achieved in an economic environment characterized
by uneven global growth and heightened sensitivity to
economic news such as concerns for economic growth in
China and the ongoing Ukraine/Russia crisis.
In the fixed income markets, the Federal Reserve kept
the target rate and discount rate steady while tapering the
bond-buying program. The yield curve steepened over the
year but flattened in the last quarter as many long-dated
yields declined.
The lowest yielding fixed income sector for the year was
U.S. Treasury Inflation Protected Securities (“TIPS”), as
measured by the Barclays U.S. TIPS Index which returned
(6.5)%. The best performing fixed income sector for the
year was high yield bonds as measured by the Barclays
U.S. High Yield Bond Index which returned 7.5% as of
March 31, 2014.
Year Ended March 31, 2013
For the year ended March 31, 2013, most U.S. indices
produced positive returns. The best performing was the
S&P 400 Mid Cap Index, which returned 17.8% for the
year ended March 31, 2013. These returns were achieved
in an economic environment characterized by uneven
domestic growth and heightened sensitivity to economic
news which included improving unemployment and
housing figures, the anticipation and implementation of
the sequestration, concerns surrounding the fiscal cliff,
and periodic developments in the continuing European
sovereign debt crisis.
In the fixed income markets, the Federal Reserve affirmed
its commitment to hold the federal funds rate at historic
lows, by beginning a third round of quantitative easing and
continuing support of the secondary mortgage market.
These actions were taken to keep interest rates low and
stimulate economic growth, and resulted in a downward
shift in the yield curve over the year.
The lowest yielding fixed income sector for the year was
U.S. government bonds, as measured by the Barclays U.S.
Government Bond Index, which returned 3.0%. The best
performing fixed income sector for the year was high yield
bonds as measured by the Barclays U.S. High Yield Bond
Index, which returned 13.1% as of March 31, 2013.
Year Ended March 31, 2012
For the year ended March 31, 2012, the equity markets
ended a difficult year on a positive note, responding
favorably to improving unemployment figures, the
conclusion of bank stress tests resulting in certain banks
increasing dividends, and reduced fears of a European
debt fallout. As a result, most U.S. indices produced
positive returns for our full fiscal year. The most notable
was the NASDAQ Composite, which returned 11.2% for
the year ended March 31, 2012.
In the fixed income markets, improved economic data
suggested that the recovery was strengthening. Flights-to-
safety ebbed as the European debt crisis eased, allowing
U.S. Treasury rates to climb from historically low levels.
The yield curve steepened over the year as economic
releases from the Federal Reserve Board painted an
increasingly optimistic picture and talk of a third round of
quantitative easing diminished.
The worst performing fixed income sector for the year
was high yield bonds, as measured by the Barclays High
Yield Index, which returned 6.5%. The best performing
fixed income sector for the year was TIPS, as measured
by the Barclays U.S. TIPS Index, which returned 12.2% as
of March 31, 2012.
24
Legg Mason The following table presents a summary of the percentages of our AUM by strategy(1) that outpaced their respective
benchmarks as of March 31, 2014, 2013 and 2012, for the trailing 1-year, 3-year, 5-year, and 10-year periods:
As of March 31, 2014
As of March 31, 2013
As of March 31, 2012
1-year
3-year
5-year
10-year
1-year
3-year
5-year 10-year 1-year
3-year
5-year 10-year
Total (includes liquidity)
75%
87%
84%
92%
84%
85%
88%
91% 62%
81%
70%
87%
Equity:
Large cap
Small cap
Total equity
(includes other
equity)
Fixed income:
67%
33%
91%
26%
52%
29%
76%
82%
65%
13%
68%
15%
88%
27%
80% 66%
62% 49%
43%
63%
66%
88%
78%
89%
54%
69%
45%
77%
48%
50%
62%
71% 53%
52%
66%
80%
U.S. taxable
94%
94%
94%
97%
96%
94%
91%
90% 66%
U.S. tax-exempt
0% 100% 100% 100% 100% 100% 100% 100%
2%
Global taxable
Total fixed income
54%
74%
82%
91%
98%
96%
93%
96%
89%
94%
94%
94%
95%
93%
98% 38%
94% 51%
95%
2%
93%
87%
61%
2%
70%
60%
89%
1%
97%
84%
The following table presents a summary of the percentages of our U.S. mutual fund assets(2) that outpaced their Lipper
category averages as of March 31, 2014, 2013 and 2012, for the trailing 1-year, 3-year, 5-year, and 10-year periods:
As of March 31, 2014
As of March 31, 2013
As of March 31, 2012
1-year
3-year
5-year
10-year
1-year
3-year
5-year 10-year 1-year
3-year
5-year 10-year
Total (includes liquidity)
44%
63%
56%
68%
59% 57% 70% 64% 67% 66% 78%
74%
Equity:
Large cap
Small cap
Total equity
(includes other
equity)
Fixed income:
U.S. taxable
U.S. tax-exempt
Global taxable
Total fixed income
49%
27%
86%
19%
55%
25%
54%
72%
90% 79% 77% 40% 78%
51%
48% 45%
27% 16% 48% 68% 44% 63% 93% 98%
39%
55%
42%
60%
56% 44% 59% 53% 57% 56% 73%
71%
80%
27%
27%
54%
85%
61%
86%
78%
92%
68%
84%
83%
85%
86%
86%
86%
74%
92% 85% 90% 76%
50% 57% 86% 84%
91%
91%
70%
82% 83%
91%
82%
71%
74%
95% 54% 96% 81%
87% 83%
64% 76% 87% 85% 84%
81%
87% 83%
(1) For purposes of investment performance comparisons, strategies are an aggregation of discretionary portfolios (separate accounts, investment funds,
and other products) into a single group that represents a particular investment objective. In the case of separate accounts, the investment performance
of the account is based upon the performance of the strategy to which the account has been assigned. Each of our asset managers has its own specific
guidelines for including portfolios in their strategies. For those managers which manage both separate accounts and investment funds in the same strat-
egy, the performance comparison for all of the assets is based upon the performance of the separate account.
As of March 31, 2014, 2013 and 2012, 91%, 90% and 91% of total AUM is included in strategy AUM, respectively, although not all strategies have three-,
five-, and ten-year histories. Total strategy AUM includes liquidity assets. Certain assets are not included in reported performance comparisons. These
include: accounts that are not managed in accordance with the guidelines outlined above; accounts in strategies not marketed to potential clients; accounts
that have not yet been assigned to a strategy; and certain smaller products at some of our affiliates.
Past performance is not indicative of future results. For AUM included in institutional and retail separate accounts and investment funds included in the
same strategy as separate accounts, performance comparisons are based on gross-of-fee performance. For investment funds (including fund-of-hedge
funds) which are not managed in a separate account format, performance comparisons are based on net-of-fee performance. These performance com-
parisons do not reflect the actual performance of any specific separate account or investment fund; individual separate account and investment fund
performance may differ.
Certain prior year amounts have been updated to conform to the current year presentation.
(2) Source: Lipper Inc. includes open-end, closed-end, and variable annuity funds. As of March 31, 2014, 2013 and 2012, the U.S. long-term mutual fund
assets represented in the data accounted for 20%, 19% and 18%, respectively, of our total AUM. The performance of our U.S. long-term mutual fund
assets is included in the strategies.
25
Legg Mason
The following table presents a summary of the absolute and relative performance compared to the applicable benchmark
for a representative sample of funds within our AUM, net of management and other fees as of the end of the period
presented, for the 1-year, 3-year, 5-year, and 10-year periods, and from each fund’s inception. The table below includes
a representative sample of funds from each significant subclass of our investment strategies (i.e., large cap equity, small
cap equity, etc.). The funds within this group are representative of the performance of significant investment strategies
we offer, that as of March 31, 2014, constituted an aggregate of approximately $410 billion, or approximately 58% of
our total AUM. The only meaningful exclusions are our funds-of-hedge funds strategies, which involve privately placed
hedge funds, and represent only 3% of our total assets under management as of March 31, 2014, for which investment
performance is not made publicly available. Providing investment returns of funds provides a relevant representation of
our performance while avoiding the many complexities relating to factors such as multiple fee structures, bundled pricing,
and asset level break points, that would arise in reporting performance for strategies or other product aggregations.
Fund Name/Index
Equity
Large Cap
Inception
Date
Performance
Type(1)
Annualized Absolute/Relative Total Return (%)
vs. Benchmark
1-year
3-year
5-year
10-year
Inception
ClearBridge Appreciation Fund
3/10/1970
Absolute
18.42% 13.56% 18.47%
7.46% 10.44%
S&P 500
ClearBridge All Cap Value
Russell 3000 Value
Relative
(3.43)% (1.10)% (2.69)%
0.04% (0.06)%
11/12/1981
Absolute
18.34%
9.70% 18.86%
5.34% 10.44%
Relative
(3.32)% (4.93)% (3.02)%
(2.28)% (1.73)%
Legg Mason Capital Management Value Trust
4/16/1982
Absolute
27.64% 14.94% 21.69%
2.25% 12.15%
S&P 500
Relative
5.78%
0.29%
0.53%
(5.16)%
0.20%
ClearBridge Aggressive Growth Fund
10/24/1983
Absolute
32.29% 19.97% 26.69%
8.50% 12.66%
Russell 3000 Growth
Relative
8.76%
5.44%
4.75%
ClearBridge Large Cap Value Fund
12/31/1988
Absolute
21.75% 15.22% 20.51%
0.55%
7.37%
2.69%
9.70%
Russell 1000 Value
ClearBridge Equity Income
Russell 3000 Value
Relative
0.18%
0.42% (1.25)%
(0.22)% (0.87)%
11/6/1992
Absolute
15.20% 14.02% 18.12%
6.70%
8.66%
Relative
(6.46)% (0.61)% (3.76)%
(0.91)% (1.60)%
ClearBridge Large Cap Growth Fund
8/29/1997
Absolute
24.40% 16.70% 19.81%
Relative
1.18%
2.07% (1.87)%
6.18%
(1.69)%
7.67%
2.14%
9/7/2010
Absolute
21.33% 14.97%
Relative
(0.24)%
0.17%
n/a
n/a
n/a
n/a
18.74%
0.82%
Russell 1000 Growth
Legg Mason Brandywine Diversified
Large Cap Value Fund
Russell 1000 Value
Small Cap
Royce Pennsylvania Mutual
6/30/1967
Absolute
23.18% 10.95% 23.36%
9.36% 12.23%
Russell 2000
Royce Premier Fund
Russell 2000
Royce Total Return Fund
Russell 2000
Royce Special Equity
Russell 2000
Relative
(1.72)% (2.23)% (0.95)%
0.82%
n/a
12/31/1991
Absolute
21.85%
9.27% 22.07%
10.99% 12.61%
Relative
(3.05)% (3.91)% (2.24)%
2.46%
2.58%
12/15/1993
Absolute
20.65% 12.19% 21.61%
8.70% 11.60%
Relative
(4.25)% (0.99)% (2.70)%
0.17%
2.39%
5/1/1998
Absolute
18.15% 11.95% 19.99%
8.86% 10.12%
Relative
(6.75)% (1.24)% (4.33)%
0.33%
2.57%
ClearBridge Small Cap Growth
7/1/1998
Absolute
26.46% 16.88% 26.18%
9.85% 11.23%
Russell 2000 Growth
Fixed Income
U.S. Taxable
Relative
(0.74)%
3.27%
0.94%
0.99%
4.69%
Western Asset Core Bond Fund
9/4/1990
Absolute
Barclays US Aggregate
Relative
Western Asset Short Term Bond Fund
11/11/1991
Absolute
0.85%
0.94%
0.58%
Citi Treasury Gov’t/Credit 1–3 YR
Relative
(0.09)%
4.37% 10.86%
0.62%
1.50%
0.33%
6.06%
5.38%
3.46%
4.95%
0.49%
1.94%
7.26%
0.68%
3.87%
(0.88)% (0.71)%
26
Legg Mason
1.75%
1.65%
5.29%
5.13%
6.75% 14.52%
0.94%
3.84%
0.71%
5.63%
7.63%
3.45%
5.06% 10.90%
1.31%
3.26%
6.10%
5.38%
0.48%
1.79%
2.97%
0.08% (0.11)%
4.52%
(0.68)%
4.79%
0.85%
5.80%
1.34%
4.41%
6.76%
0.04%
7.62%
2.06%
6.55%
1.13%
5.82%
(0.11)% (0.17)%
0.60%
9.83%
5.03%
n/a
n/a
(0.71)% (1.20)%
n/a
n/a
n/a
n/a
5.42%
0.19%
18.55%
11.34%
Fund Name/Index
Inception
Date
Performance
Type(1)
Annualized Absolute/Relative Total Return (%)
vs. Benchmark
1-year
3-year
5-year
10-year
Inception
Western Asset Adjustable Rate Income
6/22/1992
Absolute
Citi T-Bill 6-Month
Relative
Western Asset Corporate Bond Fund
11/6/1992
Absolute
Barclays US Credit
Relative
Western Asset Intermediate Bond Fund
7/1/1994
Absolute
Barclays Intermediate Gov’t/Credit
Western Asset Core Plus Fund
Barclays US Aggregate
Relative
7/8/1998
Absolute
Relative
0.85%
0.76%
3.47%
2.46%
0.26%
0.39%
1.13%
1.23%
Western Asset Inflation Index Plus Bond
3/1/2001
Absolute
(6.47)%
Barclays US TIPS
Western Asset High Yield Fund
Barclays US Corp High Yield
9/28/2001
Absolute
6.79%
8.40% 18.85%
7.98%
8.46%
Relative
0.02% (0.24)%
Relative
(0.75)% (0.60)%
Western Asset Total Return Unconstrained
7/6/2006
Absolute
1.75%
3.50%
Barclays US Aggregate
Relative
1.84% (0.25)%
Western Asset Mortgage Defined Opportunity
Fund Inc.
2/24/2010
Absolute
13.77% 16.03%
BOFAML Floating Rate Home Loan Index
Relative
10.37% 10.44%
U.S. Tax-Exempt
Western Asset Managed Municipals Fund
3/4/1981
Absolute
Barclays Municipal Bond
Global Taxable
Legg Mason Western Asset Australian
Bond Trust
UBS Australian Composite Bond Index
Relative
6/30/1983
Absolute
Relative
Western Asset Global High Yield Bond Fund
2/22/1995
Absolute
(0.96)%
(1.35)%
7.55%
1.76%
7.42%
1.71%
4.97%
0.52%
7.98%
0.50%
4.36%
1.04%
5.53%
7.66%
0.92%
7.77%
8.14%
2.19%
17.78%
6.70%
0.65%
7.21%
6.42%
0.64%
7.95%
Barclays Global High Yield
Relative
(3.47)% (1.54)% (0.96)%
(2.17)% (1.98)%
Legg Mason Western Asset Core Plus Global
Bond Trust
2/28/1995
Absolute
2.94%
8.24% 11.72%
5.91%
5.98%
Barclays Global Aggregate (AUD Hedged)
Relative
Western Asset Emerging Markets Debt
10/17/1996
Absolute
(0.74)%
(3.75)%
0.22%
3.38%
(1.36)% (1.02)%
4.63% 12.67%
8.20% 10.44%
JPM EMBI Global
Legg Mason Western Asset Global Multi
Relative
(2.70)% (2.52)%
1.13%
(0.11)%
0.83%
Strategy Fund
8/31/2002
Absolute
(1.02)%
2.80%
9.51%
5.37%
7.24%
50% Bar. Global Agg./25% Bar. HY 2%/25%
JPM EMBI +
Relative
(3.37)% (2.53)% (0.27)%
(1.22)% (0.96)%
Legg Mason Brandywine Global Fixed Income
10/31/2003
Absolute
Citi World Gov’t Bond
Relative
Legg Mason Brandywine Global Opportunities
Bond
Citi World Gov’t Bond
Liquidity
11/1/2006
Absolute
Relative
(0.50)%
(1.87)%
0.60%
(0.78)%
4.22%
2.31%
6.22%
4.31%
9.09%
5.25%
5.02%
0.79%
11.51%
7.67%
n/a
n/a
5.46%
0.65%
7.24%
2.67%
Western Asset Institutional Cash Reserves Ltd.
12/31/1989
Absolute
Citi 3-Month T-Bill
Relative
0.08%
0.03%
0.14%
0.08%
0.21%
0.12%
1.89%
0.32%
3.57%
0.31%
(1) Absolute performance is the actual performance (i.e., rate of return) of the fund. Relative performance is the difference (or variance) between the perfor-
mance of the fund and its stated benchmark.
27
Legg Mason
BUSINESS MODEL STREAMLINING INITIATIVE
In May 2010, we announced an initiative to streamline our
business model to drive increased profitability and growth
that primarily involved transitioning certain shared services
to our investment affiliates who are closer to the actual
client relationships. The initiative resulted in over $140
million in annual cost savings, substantially all of which
were cash savings. These cost savings consisted of (i) over
$80 million in compensation and benefits cost reductions
resulting from eliminating positions in certain corporate
shared services functions as a result of transitioning
such functions to the affiliates, and charging affiliates
for other centralized services that have continued to be
provided to them without any corresponding adjustment in
revenue sharing or other compensation arrangements; (ii)
approximately $50 million in non-compensation costs from
eliminating and streamlining activities in our corporate and
distribution business units, including savings associated
with consolidating office space; and (iii) approximately $10
million from our global distribution group sharing in affiliate
revenues from retail assets under management without
any corresponding adjustment in revenue sharing or other
compensation arrangements.
The initiative involved $127.5 million in transition-related
costs that primarily included charges for employee
termination benefits and incentives to retain employees
during the transition period. The transition-related
costs also included charges for consolidating leased
office space, early contract terminations, accelerated
depreciation of fixed assets, asset disposals and
professional fees. During the year ended March 31, 2012,
transition-related costs totaled $73.1 million. All transition-
related costs were accrued as of the completion of the
initiative on March 31, 2012. We achieved total annual
cost savings from the initiative of approximately $140
million and $97 million as of March 31, 2013 and 2012,
respectively, when compared to similar expenses prior
to the commencement of the streamlining initiative. A
portion of the estimated transition-related savings in fiscal
2013 were incremental to fiscal 2012, and are explained,
where applicable, in the results of operations discussion
to follow. See Note 15 of Notes to Consolidated Financial
Statements for additional information on our business
streamlining initiative.
RESULTS OF OPERATIONS
In accordance with financial accounting standards on
consolidation, we consolidate and separately identify
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 our
consolidated operating results. We also hold investments
in other consolidated sponsored investment funds and
the change in the value of these investments, which
is recorded in Other non-operating income (expense),
is reflected in our Net Income (Loss), net of amounts
allocated to noncontrolling interests, if any. See Notes 1,
3, and 17 of Notes to Consolidated Financial Statements
for additional information regarding the consolidation of
investment vehicles.
Operating Revenues
The components of total operating revenues (in millions), and the dollar and percentage changes between periods were
as follows:
Years Ended March 31,
2014 Compared to 2013
2013 Compared to 2012
2014
2013
2012
$ Change % Change
$ Change % Change
Investment advisory fees:
Separate accounts
$ 777.4
$ 730.3
$ 775.5
$ 47.1
6.4%
$(45.2)
(5.8)%
Funds
Performance fees
Distribution and service fees
Other
1,501.3
1,446.1
1,491.3
107.1
347.6
8.4
98.6
330.5
7.2
49.5
341.0
5.3
55.2
8.5
17.1
1.2
Total operating revenues
$2,741.8
$2,612.7
$2,662.6
$129.1
3.8
8.6
5.2
16.7
4.9%
(45.2)
49.1
(10.5)
1.9
(3.0)
99.2
(3.1)
35.8
$(49.9)
(1.9)%
28
Legg Mason Total operating revenues for the year ended March 31,
2014, were $2.74 billion, an increase of 4.9% from $2.61
billion for the year ended March 31, 2013. This increase
was primarily due to the impact of a 3% increase in
average long-term AUM and an increase in average AUM
advisory revenue yields, from 33.7 basis points in the
year ended March 31, 2013 to 34.1 basis points in the
year ended March 31, 2014. The increase in average AUM
advisory revenue yields was the result of a slightly more
favorable average asset mix, with equity assets, which
generally earn higher fees than fixed income and liquidity
assets, comprising a slightly higher percentage of our
total average AUM for the year ended March 31, 2014, as
compared to the year ended March 31, 2013.
Total operating revenues for the year ended March 31,
2013, were $2.61 billion, a decrease of 1.9% from $2.66
billion for the year ended March 31, 2012, despite average
AUM remaining essentially flat. This decrease was
primarily due to the impact of a reduction in average AUM
advisory revenue yields, from 35.2 basis points in the year
ended March 31, 2012, to 33.7 basis points in the year
ended March 31, 2013. The reduction in average AUM
advisory revenue yields was the result of a less favorable
average asset mix, with equity assets, which generally
earn higher fees than fixed income and liquidity assets,
comprising a lower percentage of our total average AUM
for the year ended March 31, 2013, as compared to the
year ended March 31, 2012. This decrease was offset in
part by a $49.1 million increase in performance fees.
Investment Advisory Fees from Separate Accounts
For the year ended March 31, 2014, investment advisory
fees from separate accounts increased $47.1 million, or
6.4%, to $777.4 million, as compared to $730.3 million for
the year ended March 31, 2013. Of this increase, $32.8
million was the result of higher average equity assets
managed by ClearBridge, $23.2 million resulted from
higher revenues at Permal, including those resulting from
the acquisition of Fauchier in March 2013, and $7.9 million
was due to higher average fixed income assets managed
by Brandywine. These increases were offset in part by
a decrease of $17.6 million due to lower average equity
assets managed by Batterymarch and a decrease of $6.8
million due to the sale of a small affiliate in August 2013.
For the year ended March 31, 2013, investment advisory
fees from separate accounts decreased $45.2 million, or
5.8%, to $730.3 million, as compared to $775.5 million for
the year ended March 31, 2012. Of this decrease, $41.5
million was the result of lower average equity assets
managed by Batterymarch, LMCM and Legg Mason
Global Equities Group (“LMGE”), and $12.3 million was
due to the divestiture of an affiliate in February 2012.
These decreases were offset in part by an increase of
$9.6 million due to higher average fixed income assets
managed by Brandywine.
Investment Advisory Fees from Funds
For the year ended March 31, 2014, investment advisory
fees from funds increased $55.2 million, or 3.8%, to $1.5
billion, as compared to $1.4 billion for the year ended
March 31, 2013. Of this increase, $85.6 million was due
to higher average equity assets managed by ClearBridge
and $16.5 million was due to higher average fixed income
assets managed by Brandywine, offset in part by a
decrease of $48.7 million due to lower average fixed
income assets managed by Western Asset.
For the year ended March 31, 2013, investment advisory
fees from funds decreased $45.2 million, or 3.0%, to
$1.4 billion, as compared to $1.5 billion for the year ended
March 31, 2012. Of this decrease, $52.9 million was due
to lower average assets managed by Permal, and $48.7
million was due to lower average equity assets managed
by Royce, LMCM and LMGE. These decreases were
offset in part by a $39.1 million increase as a result of
higher average fixed income assets managed by Western
Asset and Brandywine, and a $16.7 million increase as a
result of higher average equity assets at ClearBridge.
Performance Fees
Of our total AUM as of March 31, 2014, 2013, and 2012,
approximately 6% was in accounts that were eligible to
earn performance fees. For the year ended March 31,
2014, performance fees increased $8.5 million to $107.1
million, as compared to $98.6 million for the year ended
March 31, 2013, primarily due to higher fees earned on
assets managed at Permal, including those resulting from
the Fauchier acquisition, offset in part by the impact of
$32.0 million of fees received by Western Asset in the
prior year, related to the wind-down of its participation in
the U.S. Treasury’s Public-Private Investment Program
(“PPIP”). Strong performance fees were heavily
influenced by strong equity markets in fiscal 2014.
For the year ended March 31, 2013, performance fees
increased $49.1 million to $98.6 million, as compared to
$49.5 million for the year ended March 31, 2012, primarily
due to $32.0 million of fees received by Western Asset
related to the wind-down of its participation in the PPIP.
Higher fees earned on assets managed at Permal and
Brandywine also contributed to the increase.
Distribution and Service Fees
For the year ended March 31, 2014, distribution and
service fees increased $17.1 million, or 5.2%, to $347.6
million, as compared to $330.5 million for the year ended
29
Legg Mason March 31, 2013, resulting from an increase in average fee
rates received on mutual fund AUM subject to distribution
and service fees.
For the year ended March 31, 2013, distribution and
service fees decreased $10.5 million, or 3.1%, to $330.5
million, as compared to $341.0 million for the year ended
March 31, 2012, resulting from a decline in average fee
rates received on mutual fund AUM subject to distribution
and service fees.
Operating Expenses
The components of total operating expenses (in millions), and the dollar and percentage changes between periods were
as follows:
Years Ended March 31,
2014 Compared to 2013
2013 Compared to 2012
2014
2013
2012
$ Change % Change
$ Change % Change
Compensation and benefits
$1,210.4
$1,188.5
$1,144.3
$ 21.9
1.8%
$ 44.2
3.9%
Distribution and servicing
Communications and technology
Occupancy
Amortization of intangible assets
Impairment of intangible assets
Other
619.1
157.9
115.2
12.3
—
196.0
600.6
149.7
171.9
14.0
734.0
188.4
649.7
164.7
154.8
19.6
—
190.7
18.5
8.2
(56.7)
(1.7)
3.1
5.5
(33.0)
(12.1)
(734.0)
n/m
7.6
4.0
(49.1)
(15.0)
17.1
(5.6)
734.0
(2.3)
(7.6)
(9.1)
11.0
(28.6)
n/m
(1.2)
Total operating expenses
$2,310.9
$3,047.1
$2,323.8
$(736.2)
(24.2)%
$723.3
31.1%
n/m—not meaningful
Total operating expenses for the year ended March 31,
2014, were $2.31 billion, a decrease of 24.2% from $3.05
billion, for the year ended March 31, 2013. Total operating
expenses for the year ended March 31, 2013, were $3.05
billion, an increase of 31.1% from $2.32 billion for the
year ended March 31, 2012. The change in total operating
expenses for both fiscal 2014 and fiscal 2013, was
primarily the result of $734.0 million of intangible asset
impairment charges recorded during fiscal 2013, as further
discussed below.
Operating expenses for the years ended March 31, 2014,
2013, and 2012, incurred at the investment management
affiliate level comprised approximately 70% of total
operating expenses in each year, excluding the impairment
charges, which are deemed to be corporate expenses.
The remaining operating expenses are comprised of
corporate and distribution costs.
30
Legg Mason Compensation and Benefits
The components of Total Compensation and Benefits (in millions) for the years ended March 31 were as follows:
Years Ended March 31,
2014 Compared to 2013
2013 Compared to 2012
2014
2013
2012
$ Change % Change
$ Change % Change
Salaries and incentives
$ 952.9
$ 924.5
$ 895.0
Benefits and payroll taxes
Transition-related costs
Management transition
compensation costs
Other
219.7
—
4.0
33.8
204.5
—
17.9
41.6
196.7
34.6
—
18.0
$ 28.4
15.2
3.1%
7.4
—
n/m
(13.9)
(7.8)
(77.7)
(18.8)
$ 29.5
7.8
(34.6)
17.9
23.6
3.3%
4.0
n/m
n/m
131.1
Total Compensation and Benefits
$1,210.4
$1,188.5
$1,144.3
$ 21.9
1.8%
$ 44.2
3.9%
n/m—not meaningful
Total Compensation and Benefits for the year ended
March 31, 2014, increased 1.8% to $1.21 billion, as
compared to $1.19 billion for the year ended March 31,
2013; and for the year ended March 31, 2013, increased
3.9% to $1.19 billion, as compared to $1.14 billion for the
year ended March 31, 2012:
• Salaries and incentives increased $28.4 million, to
$952.9 million for the year ended March 31, 2014, as
compared to $924.5 million for the year ended March
31, 2013, principally due to an increase of $11.7 million
in incentive-based compensation at investment
affiliates, primarily resulting from higher revenues, and
an increase of $11.7 million in incentive-based
compensation for corporate and distribution
personnel, partially as a result of increased retail sales.
• Salaries and incentives increased $29.5 million, to
$924.5 million for the year ended March 31, 2013, as
compared to $895.0 million for the year ended March
31, 2012, principally due to an increase of $38.5
million in incentive-based compensation at
investment affiliates, primarily resulting from costs
associated with the modification of employment and
other arrangements, most significantly with the
management of Permal, and the impact of reductions
in other non-compensation related operating
expenses at revenue share based affiliates, which
create an offsetting increase in compensation per the
applicable revenue share agreements. Additional
salary and incentive costs of $12.2 million, resulting
from market-based compensation increases among
retained staff and new hires to support ongoing
growth initiatives, also contributed to the increase.
These increases were offset in part by a $23.7
million decrease in corporate salaries primarily due to
headcount reductions resulting from our business
streamlining initiative.
• Benefits and payroll taxes increased $15.2 million, to
$219.7 million for the year ended March 31, 2014, as
compared to $204.5 million for the year ended March
31, 2013, primarily as a result of $4.4 million of costs
associated with the previously discussed corporate
initiatives, a $3.5 million increase in costs associated
with certain employee benefit plans, a $2.5 million
increase in health insurance expense, and a $2.2 million
increase in payroll-related taxes.
• Benefits and payroll taxes increased $7.8 million, to
$204.5 million for the year ended March 31, 2013, as
compared to $196.7 million for the year ended March
31, 2012, primarily as a result of an increase in non-
cash amortization expense and other costs associated
with certain deferred compensation plans.
• Transition-related costs of $34.6 million for the year
ended March 31, 2012, represent costs related to our
business streamlining initiative, which was
completed in March 2012.
• Management transition compensation costs of
$4.0 million for the year ended March 31, 2014,
represent amortization expense related to retention
awards granted to certain executives and key
employees in the prior year.
• Management transition compensation costs of
$17.9 million for the year ended March 31, 2013, were
associated with our Chief Executive Officer stepping
down in September 2012 and the subsequent
reorganization of our executive committee. These
costs were primarily comprised of $7.5 million of cash
severance and $6.4 million of net non-cash
accelerated vesting of stock based awards. Also
included in this line item was $3.0 million of non-cash
amortization expense related to retention awards
granted to certain executives and key employees.
• Other compensation and benefits decreased
$7.8 million, to $33.8 million for the year ended
31
Legg Mason March 31, 2014, as compared to $41.6 million for
the year ended March 31, 2013, primarily due to a
$19.5 million decrease in deferred compensation and
revenue-share based incentive obligations resulting
from a reduction in net market gains on assets
invested for deferred compensation plans and seed
capital investments, which were partially offset by
corresponding decreases in Other non-operating
income (expense). These decreases were offset, in
part, by an $11.7 million increase in severance
expense to $16.8 million, primarily related to the
previously discussed corporate initiatives.
• Other compensation and benefits increased
$23.6 million, to $41.6 million, as compared to
$18.0 million for the year ended March 31, 2012,
primarily due to an increase in revenue-share based
incentive obligations resulting from a $22.7 million
increase in net market gains on assets invested for
deferred compensation plans and seed capital
investments, which were offset by corresponding
increases in Other non-operating income (expense).
For the year ended March 31, 2014, compensation as a
percentage of operating revenues decreased to 44.1%
from 45.5% for the year ended March 31, 2013, due to the
impact of compensation decreases related to a reduction
in net market gains on assets invested for deferred
compensation plans and seed capital investments and
the compensation impact of the wind-down of Western
Asset’s participation in the PPIP in fiscal 2013.
For the year ended March 31, 2013, compensation as a
percentage of operating revenues increased to 45.5%
from 43.0% for the year ended March 31, 2012, due to the
impact of reductions in other non-compensation related
operating expenses at revenue share based affiliates,
the impact of the modification of employment and other
arrangements, as well as the impact of quasi-fixed
compensation costs of administrative and distribution
personnel which do not typically vary with revenues. These
increases were offset in part by the impact of transition-
related compensation recorded in fiscal 2012, as well as the
impact of lower corporate compensation costs, principally
attributable to our business streamlining initiative.
Distribution and Servicing
For the year ended March 31, 2014, distribution and
servicing expenses increased 3.1% to $619.1 million, as
compared to $600.6 million for the year ended March 31,
2013, with $15.2 million of the increase due to an increase
in average AUM in certain products for which we pay fees
to third-party distributors.
For the year ended March 31, 2013, distribution and
servicing expenses decreased 7.6% to $600.6 million,
as compared to $649.7 million for the year ended March
31, 2012, driven by a $53.8 million decrease due to a
reduction in average AUM in certain products for which
we pay fees to third-party distributors.
Communications and Technology
For the year ended March 31, 2014, communications and
technology expense increased 5.5% to $157.9 million, as
compared to $149.7 million for the year ended March 31,
2013, primarily as a result of an increase in technology
consulting, market data, and telephone expenses.
For the year ended March 31, 2013, communications
and technology expense decreased 9.1% to $149.7
million, as compared to $164.7 million for the year ended
March 31, 2012, driven by the impact of $8.4 million in
transition-related costs recognized in fiscal 2012, as well
as $4.4 million in cost savings as a result of our business
streamlining initiative.
Occupancy
For the year ended March 31, 2014, occupancy expense
decreased 33.0% to $115.2 million, as compared to
$171.9 million for the year ended March 31, 2013, primarily
due to the impact of real estate related charges totaling
$52.8 million recognized in fiscal 2013 and a $4.6 million
decrease in rent expense, primarily as a result of lease
reserves taken on vacant space in fiscal 2013. These
decreases were offset in part by $7.9 million in real estate
related charges taken during fiscal 2014 in connection with
the previously discussed corporate initiatives.
For the year ended March 31, 2013, occupancy expense
increased 11.0% to $171.9 million, as compared to $154.8
million for the year ended March 31, 2012, primarily due to
real estate related charges totaling $52.8 million, recorded
during fiscal 2013 related to further space consolidation
which resulted in savings of approximately $10.0 million
per year beginning in fiscal 2014. This increase was offset
in part by the impact of $11.9 million of lease reserves
recorded in fiscal 2012, as well as the acceleration of
$10.3 million of depreciation in fiscal 2012, both primarily
related to certain office space permanently vacated as a
part of our business streamlining initiative. The increase
was also offset in part by $6.0 million in cost savings, also
as a result of our business streamlining initiative.
Amortization and Impairment of Intangible Assets
For the year ended March 31, 2014, amortization of
intangible assets decreased 12.1% to $12.3 million, as
compared to $14.0 million for the year ended March 31,
2013, primarily due to certain management contracts
becoming fully amortized in December 2013.
32
Legg Mason For the year ended March 31, 2013, amortization of
intangible assets decreased 28.6% to $14.0 million, as
compared to $19.6 million for the year ended March 31,
2012, primarily due to certain management contracts
becoming fully amortized during fiscal 2012.
Impairment of intangible assets was $734.0 million
in the year ended March 31, 2013. The impairment
charges related to our domestic mutual fund contracts
asset, Permal funds-of-hedge fund contracts asset, and
Permal trade name. The impairment charges resulted
from a number of trends and factors, which resulted in
a reduction of the projected cash flows and our overall
assessment of fair value of the assets, such that the
domestic mutual fund contracts asset, Permal funds-
of-hedge funds contracts asset, and Permal trade
name asset, declined below their carrying values, and
accordingly were impaired by $396.0 million, $321.0
million, and $17.0 million, respectively in fiscal 2013. See
Note 5 of Notes to Consolidated Financial Statements for
further discussion of the impairment charges.
Other
For the year ended March 31, 2014, other expenses
increased $7.6 million, or 4.0%, to $196.0 million, as
compared to $188.4 million for the year ended March 31,
2013, primarily due to a $14.7 million increase in expense
reimbursements paid to certain mutual funds and a $5.0
million charge for a fair value adjustment to increase the
contingent consideration liability related to the acquisition
of Fauchier, as the acquired business has performed
better than initially projected. These increases were offset
in part by an $8.0 million decrease in franchise taxes, as
well as a $5.3 million decrease in professional fees.
For the year ended March 31, 2013, other expenses
decreased $2.3 million, or 1.2%, to $188.4 million, as
compared to $190.7 million for the year ended March
31, 2012, primarily due to a $4.1 million reduction in
charges for trading errors. A $2.5 million decrease in
expense reimbursements paid to certain mutual funds,
and the impact of $1.7 million of transition-related costs
recognized in fiscal 2012, also contributed to the decrease.
These decreases were offset in part by a $5.0 million
increase in litigation-related expenses as a result of certain
resolved regulatory investigations. A $1.8 million increase
in professional fees, primarily related to initiatives with
Permal, including the acquisition of Fauchier during fiscal
2013, also offset the decrease.
Non-Operating Income (Expense)
The components of total other non-operating income (expense) (in millions), and the dollar and percentage changes
between periods were as follows:
Years Ended March 31,
2014 Compared to 2013
2013 Compared to 2012
Interest income
Interest expense
Other income (expense), net
Other non-operating income (loss)
of consolidated investment
vehicles, net
2014
$ 6.4
(52.9)
32.8
2.4
Total other non-operating expense
$(11.3)
2013
$ 7.6
(62.9)
(18.0)
2012
$ 11.5
(87.6)
22.1
(2.8)
$(76.1)
18.3
$(35.7)
$ Change % Change
$ Change % Change
$ (1.2)
10.0
50.8
5.2
$64.8
(15.8)%
$ (3.9)
(33.9)%
(15.9)
n/m
24.7
(40.1)
(28.2)
n/m
n/m
(85.2)%
(21.1)
$(40.4)
n/m
n/m
n/m—not meaningful
Interest Income
For the year ended March 31, 2014, interest income
decreased 15.8% to $6.4 million, as compared to $7.6 million
for the year ended March 31, 2013, driven by the impact of
lower average interest-bearing investment balances.
For the year ended March 31, 2013, interest income
decreased 33.9% to $7.6 million, as compared to
$11.5 million for the year ended March 31, 2012, driven
by a $2.6 million decrease due to lower yields earned on
investment balances and a $1.8 million decrease due to
lower average investment balances.
Interest Expense
For the year ended March 31, 2014, interest expense
decreased 15.9% to $52.9 million, as compared to
$62.9 million for the year ended March 31, 2013, primarily
as a result of a $5.6 million decrease in the interest
accruals for uncertain tax positions and a $4.4 million
decrease due to the refinancing of the 2.5% Convertible
33
Legg Mason Senior Notes (the “Convertible Notes”) in May 2012 and
the five-year term loan in January 2014.
For the year ended March 31, 2013, interest expense
decreased 28.2% to $62.9 million, as compared to
$87.6 million for the year ended March 31, 2012, primarily
as a result of the refinancing of the Convertible Notes in
May 2012.
Other Income (Expense), Net
For the year ended March 31, 2014, other income (expense),
net, improved $50.8 million, to income of $32.8 million, from
an expense of $18.0 million in fiscal 2013. This increase
was primarily a result of the impact of a $69.0 million loss
on debt extinguishment recognized in connection with the
repurchase of the Convertible Notes in May 2012, offset
in part by a $19.5 million decrease in net market gains on
seed capital investments and assets invested for deferred
compensation plans, which are offset by corresponding
decreases in compensation discussed above.
For the year ended March 31, 2013, other income
(expense), net, decreased $40.1 million, to an expense of
$18.0 million, from income of $22.1 million in fiscal 2012.
This decrease was primarily a result of the $69.0 million
loss on debt extinguishment recognized in connection
with the repurchase of the Convertible Notes in May 2012.
The impact of an $8.6 million gain related to an assigned
bankruptcy claim, and a $7.5 million gain on the sale of
a small affiliate, both recognized in the fiscal 2012, also
contributed to the decrease. These decreases were offset
in part by a $22.7 million increase in net market gains on
seed capital investments and assets invested for deferred
compensation plans, which are offset by corresponding
increases in compensation discussed above, as well as
a $20.8 million increase in net market gains on corporate
investments in proprietary fund products, which are not
offset in compensation.
Other Non-Operating Income (Loss) of
Consolidated Investment Vehicles
For the year ended March 31, 2014, other non-operating
income (loss) of consolidated investment vehicles
(“CIVs”), net, improved $5.2 million to income of $2.4
million, from a loss of $2.8 million in fiscal 2013, primarily
due to net market gains on investments of certain CIVs.
For the year ended March 31, 2013, other non-operating
income (expense) of CIVs, net, decreased $21.1 million
to an expense of $2.8 million, from income of $18.3
million in fiscal 2012, primarily due to net market losses
on investments of certain CIVs, as well as the impact
of market gains recognized in fiscal 2012 related to a
previously consolidated CIV that was redeemed in that
fiscal year.
Income Tax Provision (Benefit)
For the year ended March 31, 2014, the provision for
income taxes was $137.8 million, compared to an income
tax benefit of $150.9 million in the year ended March 31,
2013. The effective tax rate was 32.8% for the year ended
March 31, 2014, compared to an effective benefit rate of
29.5% in the year ended March 31, 2013. The change in
the effective rate was primarily related to a higher relative
proportion of pre-tax income (loss) in jurisdictions with
higher tax rates, substantially offset by adjustments to
deferred tax balances and other reserves.
In July 2012, the U.K. Finance Act 2012 was enacted,
which reduced the main U.K. corporate tax rate from 25%
to 24% effective April 1, 2012 and to 23% effective April
1, 2013. In July 2013, the Finance Bill 2013 was enacted,
further reducing the main U.K. corporate tax rate to 21%
effective April 1, 2014 and to 20% effective April 1, 2015.
The impact of tax rate changes on certain existing deferred
tax assets and liabilities resulted in a tax benefit of $19.2
million and $18.1 million on the revaluation of deferred tax
assets and liabilities for the years ended March 31, 2014
and 2013, respectively; and impacted the effective rate by
4.6 percentage points in the year ended March 31, 2014,
and 3.5 percentage points in the year ended March 31,
2013. The impact of CIVs increased the effective rate by
0.2 percentage points for the year ended March 31, 2014,
and reduced the effective rate by 0.5 percentage points for
the year ended March 31, 2013.
For the year ended March 31, 2013, the benefit for income
taxes was $150.9 million, compared to a provision of
$72.1 million in the prior year. The effective benefit rate
was 29.5% for the year ended March 31, 2013, compared
to an effective tax rate of 23.8% in the year ended
March 31, 2012. The change in the effective rate was
primarily related to a lower tax benefit associated with
the intangible asset impairment charge recorded in fiscal
2013, due to the lower statutory rates in the jurisdictions
where certain intangible assets were held, partially offset
by adjustments to reserves and the impact of certain tax
planning initiatives recorded in fiscal 2012.
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. As discussed above, 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 impact of the
tax rate changes on certain existing deferred tax assets
and liabilities resulted in a tax benefit of $18.1 million and
$18.3 million for the years ended March 31, 2013 and
2012, respectively, and impacted the effective rate by 3.5
percentage points in the year ended March 31, 2013, and
34
Legg Mason 6.0 percentage points in the year ended March 31, 2012.
The impact of changes in the U.K. tax rate was more
substantial for the year ended March 31, 2012, due to
the higher level of pre-tax income in that fiscal year. The
impact of CIVs reduced the effective rate by 0.5 and 0.8
percentage points for the years ended March 31, 2013 and
2012, respectively.
Supplemental Non-GAAP Financial Information
As supplemental information, we are providing performance
measures that are based on methodologies other than
generally accepted accounting principles (“non-GAAP”) for
“Adjusted Income” and “Operating Margin, As Adjusted”
that management uses as benchmarks in evaluating and
comparing our period-to-period operating performance.
Net Income (Loss) Attributable to Legg Mason, Inc.
and Operating Margin
Net Income Attributable to Legg Mason, Inc. for the year
ended March 31, 2014, totaled $284.8 million, or $2.33
per diluted share, compared to Net Loss Attributable to
Legg Mason, Inc. of $353.3 million, or $2.65 per diluted
share, in the year ended March 31, 2013. The increase
was primarily attributable to the impact of the pre-tax
impairment charges of $734.0 million ($508.3 million,
net of income tax benefits, or $3.81 per diluted share),
recorded in the prior year, the impact of the $69.0 million
pre-tax loss ($44.8 million, net of income tax benefits,
or $0.34 per diluted share) on debt extinguishment
recognized in connection with the repurchase of the
Convertible Notes in May 2012, the impact of $52.8 million
of real estate related charges recognized in fiscal 2013,
and the net impact of increased operating revenues, as
previously discussed. In addition, Net Income Attributable
to Legg Mason, Inc. per diluted share benefited from a
reduction in weighted-average shares outstanding as a
result of share repurchases. Operating margin was 15.7%
for the year ended March 31, 2014, compared to (16.6)%
for the year ended March 31, 2013.
Net Loss Attributable to Legg Mason, Inc. for the year
ended March 31, 2013, totaled $353.3 million, or $2.65
per diluted share, compared to Net Income Attributable
to Legg Mason, Inc. of $220.8 million, or $1.54 per
diluted share, in the year ended March 31, 2012. The
decrease was primarily attributable to the impact of the
pre-tax impairment charges of $734.0 million ($508.3
million, net of income tax benefits, or $3.81 per diluted
share), recorded in fiscal 2013, related to our indefinite-
life intangible assets, as well as the $69.0 million pre-tax
loss ($44.8 million, net of income tax benefits, or $0.34
per diluted share) on debt extinguishment recognized in
connection with the repurchase of the Convertible Notes
in May 2012. Real estate related charges of $52.8 million
recognized in fiscal 2013 also contributed to the decrease.
These decreases were offset in part by the impact of
transition-related costs recorded in fiscal 2012, and the
impact of increased cost savings in fiscal 2013, both in
connection with our business streamlining initiative. These
items were previously discussed above. Operating margin
was (16.6)% for the year ended March 31, 2013, compared
to 12.7% for the year ended March 31, 2012.
Adjusted Income increased to $417.8 million, or $3.41 per
diluted share, for the year ended March 31, 2014, from
$347.2 million, or $2.61 per diluted share, for the year
ended March 31, 2013. Operating Margin, as Adjusted,
for the years ended March 31, 2014 and 2013, was 22.0%
and 17.5%, respectively. Operating Margin, as Adjusted,
for the year ended March 31, 2014, was reduced by 1.5
percentage points due to expenses recognized during the
fiscal year related to the previously discussed corporate
initiatives and restructuring charges related to the QS
Investors acquisition, and by 1.0 percentage point due to
structuring fees related to a closed-end fund launch during
the fiscal year. Operating Margin, as Adjusted, for the year
ended March 31, 2013, was reduced by 3.5 percentage
points due to real estate related charges and management
transition compensation costs recorded during that fiscal
year, and by 1.0 percentage point due to structuring fees
related to closed-end fund and real estate investment trust
launches during that fiscal year.
Adjusted Income decreased to $347.2 million, or $2.61
per diluted share, for the year ended March 31, 2013, from
$397.0 million, or $2.77 per diluted share, for the year
ended March 31, 2012. Operating Margin, as Adjusted,
for the years ended March 31, 2013 and 2012, was 16.8%
and 21.3%, respectively. Operating Margin, as Adjusted,
for the year ended March 31, 2013 was reduced by 3.5
percentage points due to real estate related charges and
management transition compensation costs recorded
during fiscal 2013.
Adjusted Income
We define “Adjusted Income” as Net Income (Loss)
Attributable to Legg Mason, Inc., plus amortization
and deferred taxes related to intangible assets and
goodwill, imputed interest and tax benefits on contingent
convertible debt less deferred income taxes on goodwill
and indefinite-life intangible asset impairment, if any.
We also adjust for non-core items that are not reflective
of our economic performance, such as intangible asset
impairments, the impact of fair value adjustments of
contingent consideration liabilities, if any, the impact of
tax rate adjustments on certain deferred tax liabilities
related to indefinite-life intangible assets, and loss on
extinguishment of contingent convertible debt.
35
Legg Mason We believe that Adjusted Income provides a useful
representation of our operating performance adjusted
for non-cash acquisition related items and other items
that facilitate comparison of our results to the results
of other asset management firms that have not issued/
extinguished contingent convertible debt or made
significant acquisitions. We also believe that Adjusted
Income is an important metric in estimating the value of
an asset management business.
Adjusted Income only considers adjustments for
certain items that relate to operating performance and
comparability, and therefore, is most readily reconcilable
to Net Income (Loss) Attributable to Legg Mason, Inc.
determined under GAAP. This measure is provided
in addition to Net Income (Loss) Attributable to Legg
Mason, Inc., but is not a substitute for Net Income
(Loss) Attributable to Legg Mason, Inc. and may not
be comparable to non-GAAP performance measures,
including measures of adjusted earnings or adjusted
income, of other companies. Further, Adjusted Income is
not a liquidity measure and should not be used in place of
cash flow measures determined under GAAP. Fair value
adjustments of contingent consideration liabilities may
or may not provide a tax benefit, depending on the tax
attributes of the acquisition transaction. Our current fair
value adjustment of the contingent consideration liability
does not provide a current tax benefit. We consider
Adjusted Income to be useful to investors because it is an
important metric in measuring the economic performance
of asset management companies, as an indicator of value,
and because it facilitates comparison of our operating
results with the results of other asset management firms
that have not issued/extinguished contingent convertible
debt or made significant acquisitions.
In calculating Adjusted Income, we adjust for the impact
of the amortization of management contract assets
and impairment of indefinite-life intangible assets, and
add (subtract) the impact of fair value adjustments on
contingent consideration liabilities, if any, all of which
arise from acquisitions, to Net Income (Loss) Attributable
to Legg Mason, Inc. to reflect the fact that these items
distort comparisons of our operating results with the
results of other asset management firms that have not
engaged in significant acquisitions. Deferred taxes on
indefinite-life intangible assets and goodwill include
actual tax benefits from amortization deductions that are
not realized under GAAP absent an impairment charge
or the disposition of the related business. Because we
fully expect to realize the economic benefit of the current
period tax amortization, we add this benefit to Net Income
(Loss) Attributable to Legg Mason, Inc. in the calculation
of Adjusted Income. However, because of our net
operating loss carry-forward, we will receive the benefit
of the current tax amortization over time. Conversely, we
subtract the non-cash income tax benefits on goodwill
and indefinite-life intangible asset impairment charges and
U.K. tax rate adjustments on excess book basis on certain
acquired indefinite-life intangible assets, if applicable, that
have been recognized under GAAP. We also add back
non-cash imputed interest and the extinguishment loss on
contingent convertible debt adjusted for amounts allocated
to the conversion feature, as well as adding the actual tax
benefits on the imputed interest that are not realized under
GAAP. These adjustments reflect that these items distort
comparisons of our operating results to other periods and
the results of other asset management firms that have
not engaged in significant acquisitions, including any
related impairments, or issued/extinguished contingent
convertible debt.
Should a disposition, impairment charge or other non-core
item occur, its impact on Adjusted Income may distort
actual changes in the operating performance or value of
our firm. Accordingly, we monitor these items and their
related impact, including taxes, on Adjusted Income to
ensure that appropriate adjustments and explanations
accompany such disclosures.
Although depreciation and amortization of fixed assets
are non-cash expenses, we do not add these charges in
calculating Adjusted Income because these charges are
related to assets that will ultimately require replacement.
36
Legg Mason A reconciliation of Net Income (Loss) Attributable to Legg Mason, Inc. to Adjusted Income (in thousands except per share
amounts) is as follows:
Net Income (Loss) Attributable to Legg Mason, Inc.
Plus (less):
Amortization of intangible assets
Loss on extinguishment of 2.5% senior notes
Impairment of intangible assets
Contingent consideration fair value adjustment
Deferred income taxes on intangible assets:
Impairment charges
Tax amortization benefit
U.K. tax rate adjustment
Imputed interest on convertible debt (2.5% senior notes)
Adjusted Income
Net Income (Loss) per diluted share Attributable to
Legg Mason, Inc. common shareholders
Plus (less):
Amortization of intangible assets
Loss on extinguishment of 2.5% senior notes
Impairment of intangible assets
Contingent consideration fair value adjustment
Deferred income taxes on intangible assets:
Impairment charges
Tax amortization benefit
U.K. tax rate adjustment
Imputed interest on convertible debt (2.5% senior notes)
For the Years Ended March 31,
2014
$284,784
2013
2012
$(353,327)
$220,817
12,314
—
—
5,000
—
134,871
(19,164)
—
14,019
54,873
734,000
—
(225,748)
135,588
(18,075)
5,839
19,574
—
—
—
—
135,830
(18,268)
39,077
$417,805
$ 347,169
$397,030
$ 2.33
$ (2.65)
$ 1.54
0.10
—
—
0.04
—
1.10
(0.16)
—
0.11
0.41
5.51
—
(1.69)
1.02
(0.14)
0.04
0.14
—
—
—
—
0.95
(0.13)
0.27
Adjusted Income per diluted share
$ 3.41
$ 2.61
$ 2.77
Operating Margin, as Adjusted
We calculate “Operating Margin, as Adjusted,” by dividing
(i) Operating Income (Loss), adjusted to exclude the
impact on compensation expense of gains or losses on
investments made to fund deferred compensation plans,
the impact on compensation expense of gains or losses on
seed capital investments by our affiliates under revenue
sharing agreements, amortization related to intangible
assets, transition-related costs of streamlining our
business model, if any, income (loss) of CIVs, the impact
of fair value adjustments of contingent consideration
liabilities, if any, and impairment charges by (ii) our
operating revenues, adjusted to add back net investment
advisory fees eliminated upon consolidation of investment
vehicles, less distribution and servicing expenses which
we use as an approximate measure of revenues that are
passed through to third parties, which we refer to as
“Operating Revenues, as Adjusted.” The compensation
items, other than transition-related costs, are removed
from Operating Income (Loss) in the calculation because
they are offset by an equal amount in Other non-operating
income (expense), and thus have no impact on Net
Income (Loss) Attributable to Legg Mason, Inc. We
adjust for the impact of amortization of management
contract assets and the impact of fair value adjustments
of contingent consideration liabilities, if any, which arise
from acquisitions to reflect the fact that these items
distort comparison of our operating results with results
of other asset management firms that have not engaged
in significant acquisitions. Transition-related costs, if
any, impairment charges and income (loss) of CIVs are
removed from Operating Income (Loss) in the calculation
because these items are not reflective of our core asset
management operations. We use Operating Revenues,
as Adjusted in the calculation to show the operating
margin without distribution and servicing expenses,
which we use to approximate our distribution revenues
that are passed through to third parties as a direct cost of
37
Legg Mason selling our products, although distribution and servicing
expenses may include commissions paid in connection
with the launching of closed-end funds for which there
is no corresponding revenue in the period. Operating
Revenues, as Adjusted, also include our advisory revenues
we receive from CIVs that are eliminated in consolidation
under GAAP.
We believe that Operating Margin, as Adjusted, is a
useful measure of our performance because it provides a
measure of our core business activities. It excludes items
that have no impact on Net Income (Loss) Attributable to
Legg Mason, Inc. and indicates what our operating margin
would have been without the distribution revenues that are
passed through to third parties as a direct cost of selling our
products, amortization related to intangible assets, changes
in the fair value of contingent consideration liabilities, if any,
transition-related costs, if any, and impairment charges, and
the impact of the consolidation of certain investment
vehicles described above. The consolidation of these
investment vehicles does not have an impact on Net
Income (Loss) Attributable to Legg Mason, Inc. This
measure is provided in addition to our operating margin
calculated under GAAP, but is not a substitute for
calculations of margins under GAAP and may not be
comparable to non-GAAP performance measures, including
measures of adjusted margins of other companies.
Effective April 1, 2013, we revised our definition
of Operating Margin, as Adjusted, to add back the
amortization of intangible assets. We have applied this
change to all periods presented. The impact on results for
the years ended March 31, 2013 and 2012 were increases
of 0.7 and 1.0 percentage points, respectively.
The calculation of Operating Margin and Operating Margin, as Adjusted, is as follows (dollars in thousands):
Operating Revenues, GAAP basis
Plus (less):
For the Years Ended March 31,
2014
2013
2012
$2,741,757
$2,612,650
$2,662,574
Operating revenues eliminated upon consolidation of investment vehicles
1,950
2,397
3,094
Distribution and servicing expense excluding consolidated investment vehicles
(619,022)
(600,582)
(649,679)
Operating Revenues, as Adjusted
Operating Income (Loss), GAAP basis
Plus (less):
Gains (losses) on deferred compensation and seed investments
Transition-related costs
Impairment of intangible assets
Contingent consideration fair value adjustment
Amortization of intangible assets
Operating income and expenses of consolidated investment vehicles
Operating Income, as Adjusted
Operating Margin, GAAP basis
Operating Margin, as Adjusted
$2,124,685
$2,014,465
$2,015,989
$ 430,893
$ (434,499)
$ 338,753
16,987
—
—
5,000
12,314
2,370
36,497
—
734,000
—
14,019
2,959
13,809
73,066
—
—
19,574
3,702
$ 467,564
$ 352,976
$ 448,904
15.7%
22.0
(16.6)%
17.5
12.7%
22.3
LIQUIDITY AND CAPITAL RESOURCES
The primary objective of our capital structure is to
appropriately support our business strategies and to
provide needed liquidity at all times, including maintaining
required capital in certain subsidiaries. Liquidity and the
access to liquidity is important to the success of our
ongoing operations. Our overall funding needs and capital
base are continually reviewed to determine if the capital
base meets the expected needs of our businesses.
We intend to continue to explore potential acquisition
opportunities as a means of diversifying and strengthening
our asset management business. These opportunities may
from time to time involve acquisitions that are material in
size and may require, among other things, and subject to
existing covenants, the raising of additional equity capital
and/or the issuance of additional debt.
The consolidation of variable interest entities discussed
above does not impact our liquidity and capital resources.
We have no rights to the benefits from, nor do we bear
the risks associated with, the assets and liabilities of the
CIVs beyond our investments in and investment advisory
fees generated from these vehicles, which are eliminated
in consolidation. Additionally, creditors of the CIVs have
38
Legg Mason no recourse to our general credit beyond the level of our
investment, if any, so we do not consider these liabilities
to be our obligations.
Our assets consist primarily of intangible assets, goodwill,
cash and cash equivalents, investment securities, and
investment advisory and related fee receivables. Our
assets have been principally funded by equity capital,
long-term debt and the results of our operations. At March
31, 2014, cash and cash equivalents, total assets, long-
term debt and stockholders’ equity were $0.9 billion,
$7.1 billion, $1.0 billion and $4.7 billion, respectively. Total
assets include amounts related to CIVs of $0.2 billion.
Cash and cash equivalents are primarily invested in liquid
domestic and non-domestic money market funds that
hold principally domestic and non-domestic corporate
commercial paper and bonds, government and agency
securities, and bank deposits. We have not recognized any
losses on these investments. Our monitoring of cash and
cash equivalents mitigates the potential that material risks
may be associated with these balances.
The following table summarizes our Consolidated Statements of Cash Flows for the years ended March 31 (in millions):
Cash flows provided by operating activities
Cash flows provided by/(used in) investing activities
Cash flows used in financing activities
Effect of exchange rate changes
Net change in cash and cash equivalents
Cash and cash equivalents, beginning of period
Cash and cash equivalents, end of period
2014
$ 437.3
137.6
(639.0)
(10.9)
(75.0)
933.0
$ 858.0
2013
$ 303.3
(11.0)
(735.9)
(5.7)
(449.3)
1,382.3
$ 933.0
2012
$ 496.8
2.3
(481.8)
(10.9)
6.4
1,375.9
$1,382.3
Cash inflows provided by operating activities during fiscal
2014 were $437.3 million, primarily related to Net Income,
adjusted for non-cash items, offset in part by net sales
(purchases) of trading and other current investments
and a decrease in net activity related to CIVs, primarily
due to the wind-down of the CLO. See Note 17 of Notes
to Consolidated Financial Statements for additional
information regarding the CLO. Cash inflows provided by
operating activities during fiscal 2013 were $303.3 million,
primarily related to net sales of trading and other current
investments and results of operations, adjusted for non-
cash items, offset in part by the allocation of extinguished
debt repayment and payments for accrued compensation.
Cash inflows provided by operating activities during fiscal
2012 were $496.8 million, primarily related to Net Income,
adjusted for non-cash items.
Cash inflows provided by investing activities during fiscal
2014, were $137.6 million, primarily related to net activity
related to CIVs, offset in part by payments for fixed assets.
Cash outflows used in investing activities during fiscal
2013, were $11.0 million, primarily related to payments
related to the acquisition of Fauchier and payments made
for fixed assets, offset in part by net activity related to
CIVs. Cash inflows provided by investing activities during
fiscal 2012, were $2.3 million, primarily related to $20.2
million of net activity related to CIVs and a release of
restricted cash required for market hedge arrangements,
offset in part by payments made for fixed assets.
Cash outflows used in financing activities during fiscal
2014 were $639.0 million, primarily related to the
repayment of long-term debt of $500.4 million, the
repayment of long-term debt of CIVs of $133.0 million,
the repurchase of 9.7 million shares of our common
stock for $360.0 million, and dividends paid of $62.0
million, offset in part by the proceeds from the long-term
debt issuances of $393.7 million. Cash outflows used in
financing activities during fiscal 2013 were $735.9 million,
primarily related to the repayment of long-term debt of
$1,049.2 million, the repurchase of 16.2 million shares of
our common stock for $425.5 million, the $250.0 million
repayment of short-term debt, and dividends paid of $55.3
million, offset in part by the proceeds from the subsequent
long-term debt issuances of $1,143.2 million. Cash
outflows used in financing activities during fiscal 2012,
were $481.8 million, primarily due to the repurchase of
13.6 million shares of our common stock for $401.8 million
and dividends paid of $43.6 million.
39
Legg Mason Financing Transactions
The table below reflects our primary sources of financing (in thousands) as of March 31, 2014:
Type
5.5% senior notes
5.625% senior notes
Total at
March 31,
2014
Amount Outstanding at
March 31,
2014
2013
Interest Rate
$650,000
$650,000
$650,000
5.50%
400,000
400,000
N/A
5.625%
Maturity
May 2019
January 2044
Revolving credit agreements
Five-year amortizing term loan
750,000
—
—
—
LIBOR + 1.5% + 0.20%
annual commitment fee June 2017
—
500,000
LIBOR + 1.5%
Repaid January 2014
Capital Plan and Other Financing Transactions
In May 2012, we announced a capital plan that included
refinancing the Convertible Notes. The refinancing was
effected through the issuance of $650 million of 5.5%
senior notes, the net proceeds of which, together with
cash on hand and $250 million of remaining borrowing
capacity under a then existing revolving credit facility,
were used to repurchase all $1.25 billion of the Convertible
Notes. The terms of the repurchase included the
repayment of the Convertible Notes at par plus accrued
interest, a prepayment fee of $6.3 million, and the
issuance of warrants to the holders of the Convertible
Notes. The warrants replace a conversion feature of the
Convertible Notes, and provide for the purchase, in the
aggregate and subject to adjustment, of 14.2 million
shares of our common stock, on a net share settled basis,
at an exercise price of $88 per share. The warrants expire
in July 2017 and can be settled, at our election, in either
shares of common stock or cash.
The $650 million 5.5% senior notes are due May 2019
and were sold at a discount of $6.8 million, which is being
amortized to interest expense over the seven-year term.
Also, pursuant to the capital plan, in June 2012, we
entered into an unsecured credit agreement which
provides for a $500 million revolving credit facility and a
$500 million term loan, which was repaid in fiscal 2014,
as further discussed below. The proceeds of the term
loan were used to repay the $500 million of outstanding
borrowings under the previous revolving credit facility,
which was then terminated.
In January 2014, we issued $400 million of 5.625% senior
notes, the net proceeds of which, together with cash on
hand, were used to repay the $450 million of outstanding
borrowings under the five-year term loan entered into in
conjunction with the unsecured credit agreement noted
above. The 5.625% senior notes are due January 2044
and were sold at a discount of $6.3 million, which is being
amortized to interest expense over the 30 year term.
In January 2014, we entered into a $250 million
incremental revolving credit facility, which was
contemplated in, and is in addition to the $500 million
revolving credit facility available under, the existing credit
agreement. These revolving credit facilities are available
to fund working capital needs and for general corporate
purposes and expire in June 2017. There were no
borrowings outstanding under either of our revolving
credit facilities as of March 31, 2014.
In connection with the extinguishment of the Convertible
Notes, hedge transactions (purchased call options and
warrants) executed in connection with the initial issuance
of the Convertible Notes were also terminated.
The financial covenants under our bank agreements
include: maximum net debt to EBITDA ratio of 2.5 to 1
and minimum EBITDA to interest expense ratio of 4.0 to
1. Debt is defined to include all obligations for borrowed
money, excluding non-recourse debt of CIVs, and capital
leases. Under these net debt covenants, our debt is
reduced by the amount of our unrestricted cash in excess
of the greater of subsidiary cash or $375 million. EBITDA
is defined as consolidated net income (loss) plus/minus
tax expense (benefit), interest expense, depreciation and
amortization, amortization of intangibles, any extraordinary
expense or losses, and any non-cash charges, as defined
in the agreements. As of March 31, 2014, our net debt to
EBITDA ratio was 1.2 to 1 and EBITDA to interest expense
ratio was 12.5 to 1, and, therefore, we have maintained
compliance with the applicable covenants. In addition,
the 5.5% senior notes are subject to certain nonfinancial
covenants, including provisions relating to dispositions of
certain assets, which could require a percentage of any
related proceeds to be applied to accelerated repayments.
If our net income (loss) significantly declines, or if we
spend our available cash, it may impact our ability to
maintain compliance with the financial covenants. If we
determine that our compliance with these covenants
may be under pressure, we may elect to take a number
of actions, including reducing our expenses in order to
40
Legg Mason increase our EBITDA, using available cash to repay all or a
portion of our outstanding debt subject to these covenants
or seeking to negotiate with our lenders to modify the
terms or to restructure our debt. We anticipate that we
will have available cash to repay our bank debt, should it
be necessary. Using available cash to repay indebtedness
would make the cash unavailable for other uses and might
affect the liquidity discussions and conclusions. Entering
into any modification or restructuring of our debt would
likely result in additional fees or interest payments.
Our outstanding bank debt agreement is currently
impacted by the ratings of two rating agencies. The
interest rate and annual commitment fee on our revolving
lines of credit are based on the higher credit rating of the
two rating agencies. In June 2011, our rating by one of
these agencies was downgraded one notch below the
other. Should the other agency downgrade our rating,
absent an upgrade from the former agency, our interest
costs will rise modestly. In addition, under the terms of
the 5.5% senior notes, the interest rate paid on these
notes will increase modestly if our credit ratings are
reduced below investment grade.
Also in connection with the capital plan, our board of
directors authorized $1.0 billion for additional purchases
of our common stock, $370 million of which remained
available as of March 31, 2014. The capital plan authorizes
using up to 65% of cash generated from future operations
to purchase shares of our common stock.
Other Transactions
In March 2013, we completed the acquisition of all of the
outstanding share capital of Fauchier, a leading European
based manager of funds-of-hedge funds, from BNP Paribas
Investment Partners, S.A. The transaction included an
initial cash payment of $63.4 million, which was funded
from existing cash resources. In addition, contingent
consideration of up to approximately $25 million and
approximately $33 million (using the exchange rate between
the British pound and U.S. dollar as of March 31, 2014), may
be due on or about the second and fourth anniversaries
of closing, respectively, dependent on achieving certain
levels of revenue, net of distribution costs, and subject to
a potential catch-up adjustment in the fourth anniversary
payment for any second anniversary payment shortfall.
The fair value of the contingent consideration liability was
approximately $29.6 million as of March 31, 2014, an
increase of $7.7 million from March 31, 2013, with $5.0
million attributable to revised estimates of amounts payable
and $2.7 million attributable to changes in the exchange
rate and interest amortization. We have executed currency
forwards to economically hedge the risk of movements in
the exchange rate between the U.S. dollar and the British
pound in which the estimated contingent liability payment
amounts are denominated.
In March 2014, we entered into an agreement to acquire
QS Investors, a leading customized solutions and global
quantitative equities provider, for an initial purchase
price of $11 million and contingent consideration of up to
$10 million and $20 million due on or about the second
and fourth anniversaries of the closing, respectively,
dependent on the achievement of certain net revenue
targets, and subject to a potential catch-up adjustment in
the fourth anniversary payment for any second anniversary
payment shortfall. This acquisition is expected to close in
the first quarter of fiscal 2015.
Certain of our asset management affiliates maintain
various credit facilities for general operating purposes.
Certain affiliates are also subject to the capital
requirements of various regulatory agencies. All
such affiliates met their respective capital adequacy
requirements during the periods presented.
See Notes 2 and 6 of Notes to Consolidated Financial
Statements for additional information related to the
acquisitions of Fauchier and QS Investors and our capital
plan, respectively.
Future Outlook
We expect that over the next 12 months cash generated
from our operating activities will be adequate to support
our operating and investing liquidity needs, and planned
share repurchases. We currently intend to utilize our other
available resources for any number of potential activities,
including, but not limited to, acquisitions, seed capital
investments in new products, repurchase of shares of
our common stock, repayment of outstanding debt, or
payment of increased dividends.
In June 2013 and March 2014, we implemented
management equity plans that will entitle certain key
employees of Permal and ClearBridge, respectively, to
participate in 15% of the future growth of the respective
enterprise value (subject to appropriate discounts), if any, as
further discussed in Notes 1 and 11 of Notes to Consolidated
Financial Statements. Repurchases of units granted under
the plans may impact future liquidity requirements.
In connection with the planned integration over time of
two existing affiliates, Batterymarch and LMGAA, with
QS Investors after the acquisition closes, we expect to
incur restructuring and transition costs of approximately
$35 million, of which approximately 25% are non-cash
charges. Approximately $2.5 million of these charges were
accrued as of March 31, 2014. A significant portion of
41
Legg Mason these costs will be paid in the year ending March 31, 2015.
See Note 2 for additional information.
As described above, we currently project that our cash
flows from operating activities will be sufficient to fund
our liquidity needs. As of March 31, 2014, we had over
$500 million in cash and cash equivalents in excess of our
working capital requirements. As previously discussed,
and in accordance with our capital plan, we intend to utilize
up to 65% of cash generated from future operations to
purchase shares of our common stock in the year ending
March 31, 2015. As of March 31, 2014, we also had
undrawn revolving credit facilities totaling $750 million,
expiring June 2017. We do not currently expect to raise
incremental debt or equity financing over the next 12
months beyond our current levels. However, there can be
no assurances of these expectations as our projections
could prove to be incorrect, events may occur that require
additional liquidity, such as an acquisition opportunity
or an opportunity to refinance indebtedness, or market
conditions might significantly worsen, affecting our results
of operations and generation of available cash. If these
events result in our operations and available cash being
insufficient to fund liquidity needs, we would likely seek to
manage our available resources by taking actions such as
reducing future share repurchases, cost-cutting, reducing
our expected expenditures on investments, selling assets
(such as investment securities), repatriating earnings from
foreign subsidiaries, reducing our dividend, or modifying
arrangements with our affiliates and/or employees. Should
these types of actions prove insufficient, or should a large
acquisition or refinancing opportunity arise, we may seek
to raise additional equity or debt.
At March 31, 2014, our total cash and cash equivalents
of $858 million included $306 million held by foreign
subsidiaries. During fiscal 2014, in order to increase our
cash available in the U.S. for general corporate purposes,
we implemented plans developed in prior years to
repatriate accumulated foreign earnings for which deferred
taxes had been previously accrued, and repatriated $301
million. We plan to repatriate an additional $245 million
of foreign cash over the next several years. Due to
certain tax planning strategies, we anticipate that we will
generate a tax benefit of approximately $12 million with
respect to future repatriation of accumulated earnings.
We have adjusted the tax reserve accordingly. No further
repatriation of accumulated prior period foreign earnings
is currently planned. However, if circumstances change,
we will provide for and pay any applicable additional U.S.
taxes in connection with repatriation of offshore funds. It
is not practical at this time to determine the income tax
liability that would result from any further repatriation of
accumulated foreign earnings.
Credit and Liquidity Risk
Cash and cash equivalent deposits involve certain
credit and liquidity risks. We maintain our cash and
cash equivalents with a number of high quality financial
institutions or funds and from time to time may have
concentrations with one or more of these institutions. The
balances with these financial institutions or funds and their
credit quality are monitored on an ongoing basis.
Off-Balance Sheet Arrangements
Off-balance sheet arrangements, as defined by
the Securities and Exchange Commission (“SEC”),
include certain contractual arrangements pursuant to
which a company has an obligation, such as certain
contingent obligations, certain guarantee contracts,
retained or contingent interest in assets transferred to
an unconsolidated entity, certain derivative instruments
classified as equity or material variable interests in
unconsolidated entities that provide financing, liquidity,
market risk or credit risk support. Disclosure is required
for any off-balance sheet arrangements that have, or are
reasonably likely to have, a material current or future effect
on our financial condition, results of operations, liquidity
or capital resources. We generally do not enter into off-
balance sheet arrangements, as defined, other than those
described in the Contractual Obligations section that
follows and Consolidation discussed in Critical Accounting
Policies and Notes 1 and 17 of Notes to Consolidated
Financial Statements.
CONTRACTUAL AND CONTINGENT OBLIGATIONS
We have contractual obligations to make future payments,
principally in connection with our long-term debt, non-
cancelable lease agreements, acquisition agreements
and service agreements. See Notes 6 and 8 of Notes
to Consolidated Financial Statements for additional
disclosures related to our commitments.
42
Legg Mason The following table sets forth these contractual obligations (in millions) by fiscal year, and excludes contractual obligations
of CIVs, as we are not responsible or liable for these obligations:
Contractual Obligations
Long-term borrowings by contract maturity(1)
Interest on long-term borrowings and credit facility commitment fees(1)
Minimum rental and service commitments
Total Contractual Obligations
Contingent Obligation
Payments related to business acquisition(2)
Total Contractual and Contingent Obligations(3)(4)(5)(6)
2015
2016
2017
2018
2019
Thereafter
Total
$ 0.4
$ — $ — $ — $ — $1,050.0 $1,050.4
59.8
134.3
194.5
59.8
115.7
175.5
59.8
97.6
58.7
87.1
58.3
72.9
580.4
351.2
876.8
858.8
157.4
145.8
131.2
1,981.6
2,786.0
—
25.0
10.0
33.0
20.0
—
88.0
$194.5
$200.5 $167.4
$178.8
$151.2
$1,981.6 $2,874.0
(1) Excludes current portion of long-term borrowings of the consolidated CLO of $79.2 million and interest on these borrowings, as applicable.
(2) The amount of contingent payments reflected for any year represents the maximum amount that could be payable, using the exchange rate between the
British pound and U.S. dollar as of March 31, 2014, for the amounts due in fiscal 2016 and fiscal 2018, at the earliest possible date under the terms of the
business purchase agreements. The contingent obligation had a fair value of $29.6 million as of March 31, 2014.
(3) The table above does not include approximately $34.5 million in capital commitments to investment partnerships in which Legg Mason is a limited partner.
These obligations will be funded, as required, through the end of the commitment periods running through fiscal 2021.
(4) The table above does not include amounts for uncertain tax positions of $55.7 million (net of the federal benefit for state tax liabilities), because the timing
of any related cash outflows cannot be reliably estimated.
(5) The table above does not include redeemable noncontrolling interests, primarily related to CIVs, of $45.1 million, because the timing of any related cash
outflows cannot be reliably estimated.
(6) The table above excludes potential obligations arising from the ultimate settlement of awards under the management equity plans with key employees
of Permal and ClearBridge due to the uncertainty of the timing and amounts ultimately payable. See Notes 1 and 11 of Notes to Consolidated Financial
Statements for additional information regarding management equity plans.
MARKET RISK
We maintain an enterprise risk management program
to oversee and coordinate risk management activities
of Legg Mason and its subsidiaries. Under the program,
certain risk activities are managed at the subsidiary level.
The following describes certain aspects of our business
that are sensitive to market risk.
Revenues and Net Income (Loss)
The majority of our revenue is calculated from the market
value of our AUM. Accordingly, a decline in the value
of the underlying securities will cause our AUM, and
thus our revenues, to decrease. In addition, our fixed
income and liquidity AUM are subject to the impact of
interest rate fluctuations, as rising interest rates may
tend to reduce the market value of bonds held in various
mutual fund portfolios or separately managed accounts.
In the ordinary course of our business, we may also
reduce or waive investment management fees, or limit
total expenses, on certain products or services for
particular time periods to manage fund expenses, or for
other reasons, and to help retain or increase managed
assets. Performance fees may be earned on certain
investment advisory contracts for exceeding performance
benchmarks, and strong markets tend to increase these
fees. Declines in market values of AUM will result in
reduced fee revenues and net income. We generally earn
higher fees on equity assets than fees charged for fixed
income and liquidity assets. Declines in market values of
AUM in this asset class will disproportionately impact our
revenues. In addition, under revenue sharing agreements,
certain of our affiliates retain different percentages of
revenues to cover their costs, including compensation.
Our net income (loss), profit margin and compensation as
a percentage of operating revenues are impacted based
on which affiliates generate our revenues, and a change
in AUM at one subsidiary can have a dramatically different
effect on our revenues and earnings than an equal change
at another subsidiary.
Trading and Non-Trading Assets
Our trading and non-trading assets are comprised of
investment securities, including seed capital in sponsored
mutual funds and products, limited partnerships, limited
liability companies and certain other investment products.
43
Legg Mason Trading and other current investments, excluding CIVs, at March 31, 2014 and 2013, subject to risk of security price
fluctuations are summarized below (in thousands).
Investment securities, excluding CIVs:
Trading investments relating to long-term incentive compensation plans
Trading proprietary fund products and other investments
Equity method investments relating to long-term incentive compensation plans,
proprietary fund products and other investments
Total current investments, excluding CIVs
2014
2013
$109,648
335,456
22,622
$467,726
$ 86,583
228,156
56,341
$371,080
Approximately $33.7 million and $39.2 million of trading
and other current investments related to long-term
incentive compensation plans as of March 31, 2014 and
2013, respectively, have offsetting liabilities such that
fluctuation in the market value of these assets and the
related liabilities will not have a material effect on our net
income (loss) or liquidity. However, it will have an impact
on our compensation expense with a corresponding
offset in other non-operating income (expense). Trading
and other current investments of $90.0 million and $91.1
million at March 31, 2014 and 2013, respectively, relate
to other long-term incentive plans for which the related
liabilities do not completely offset due to vesting provisions.
Therefore, fluctuations in the market value of these trading
investments will impact our compensation expense, non-
operating income (expense) and net income (loss).
Approximately $344.0 million and $240.8 million of trading
and other current investments at March 31, 2014 and
2013, respectively, are investments in proprietary fund
products and other investments for which fluctuations
in market value will impact our non-operating income
(expense). Of these amounts, the fluctuations in market
value related to approximately $19.9 million and $13.8
million of proprietary fund products as of March 31, 2014
and 2013, respectively, have offsetting compensation
expense under revenue share agreements. The fluctuations
in market value related to approximately $109.8 million
and $71.9 million in proprietary fund products as of March
31, 2014 and 2013, respectively, are substantially offset
by gains (losses) on market hedges and therefore do not
materially impact Net Income (Loss) Attributable to Legg
Mason, Inc. Investments in proprietary fund products are
not liquidated before the related fund establishes a track
record, has other investors, or a decision is made to no
longer pursue the strategy.
Non-trading assets, excluding CIVs, at March 31, 2014 and 2013, subject to risk of security price fluctuations are
summarized below (in thousands).
Investment securities, excluding CIVs:
Available-for-sale
Investments in partnerships, LLCs and other
Equity method investments in partnerships and LLCs
Other investments
Total non-trading assets, excluding CIVs
2014
2013
$ 12,072
24,464
62,973
90
$99,599
$ 12,400
31,143
68,780
99
$112,422
Investment securities of CIVs totaled $50.5 million and
$24.8 million as of March 31, 2014 and 2013, respectively,
and investments of CIVs totaled $31.8 million and $210.6
million as of March 31, 2014 and 2013, respectively. As of
March 31, 2014 and 2013, we held equity investments in
the CIVs of $39.4 million and $39.1 million, respectively.
Fluctuations in the market value of investments of CIVs
in excess of our equity investment will not impact Net
Income (Loss) Attributable to Legg Mason, Inc. However,
it may have an impact on other non-operating income
(expense) of CIVs with a corresponding offset in Net
income (loss) attributable to non-controlling interests.
Valuation of trading and non-trading investments is
described below within Critical Accounting Policies
under the heading “Valuation of Financial Instruments.”
See Notes 1 and 14 of Notes to Consolidated Financial
Statements for further discussion of derivatives.
44
Legg Mason The following is a summary of the effect of a 10% increase or decrease in the market values of our financial instruments
subject to market valuation risks at March 31, 2014 (in thousands):
Investment securities, excluding CIVs:
Trading investments relating to long-term incentive compensation plans
Trading investments of proprietary fund products and other trading investments
Equity method investments relating to long-term incentive compensation plans,
$109,648
335,456
$120,613
369,002
$ 98,683
301,910
Carrying Value
Fair Value
Assuming a
10% Increase(1)
Fair Value
Assuming a
10% Decrease(1)
proprietary fund products and other investments
Total current investments, excluding CIVs
Investments in CIVs
Available-for-sale investments
Investments in partnerships, LLCs and other
Equity method investments in partnerships and LLCs
Other investments
Total investments subject to market risk
22,622
467,726
39,434
12,072
24,464
62,973
90
24,884
514,499
43,377
13,279
26,910
69,270
99
20,360
420,953
35,491
10,865
22,018
56,676
81
$606,759
$667,434
$546,084
(1) Gains and losses related to certain investments in deferred compensation plans and proprietary fund products are directly offset by a corresponding adjust-
ment to compensation expense and related liability. In addition, investments in proprietary fund products of approximately $109.8 million have been eco-
nomically hedged to limit market risk. As a result, a 10% increase or decrease in the unrealized market value of our financial instruments subject to market
valuation risks would result in a $32.8 million increase or decrease in our pre-tax earnings as of March 31, 2014.
Also, as of March 31, 2014 and 2013, cash and cash
equivalents included $456.6 million and $485.8 million,
respectively, of money market funds.
Foreign Exchange Sensitivity
We operate primarily in the U.S., but provide services, earn
revenues and incur expenses outside the U.S. Accordingly,
fluctuations in foreign exchange rates for currencies,
principally in the U.K., Brazil, Japan, Canada, Singapore,
Australia, and those denominated in the euro, may impact
our comprehensive income (loss) and net income (loss).
We and certain of our affiliates have entered into forward
contracts to manage a portion of the impact of fluctuations
in foreign exchange rates on their results of operations.
We do not expect foreign currency fluctuations to have a
material effect on our net income (loss) or liquidity.
Interest Rate Risk
Exposure to interest rate changes on our outstanding
debt is substantially mitigated as our $650 million of
5.5% senior notes and $400 million of 5.625% senior
notes are at fixed interest rates. See Note 6 of Notes
to Consolidated Financial Statements for additional
disclosures regarding debt.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Accounting policies are an integral part of the preparation
of our financial statements in accordance with accounting
principles generally accepted in the United States of
America. Understanding these policies, therefore, is a key
factor in understanding our reported results of operations
and financial position. See Note 1 of Notes to Consolidated
Financial Statements for a discussion of our significant
accounting policies and other information. Certain critical
accounting policies require us to make estimates and
assumptions that affect the amounts of assets, liabilities,
revenues and expenses reported in the financial statements.
Due to their nature, estimates involve judgment based upon
available information. Therefore, actual results or amounts
could differ from estimates and the difference could have a
material impact on the consolidated financial statements.
We consider the following to be our critical accounting
policies that involve significant estimates or judgments.
Consolidation
In the normal course of our business, we sponsor and
are the manager of various types of investment vehicles.
For our services, we are entitled to receive management
fees and may be eligible, under certain circumstances, to
receive additional subordinate management fees or other
incentive fees. Our exposure to risk in these entities is
generally limited to any equity investment we have made
or are required to make and any earned but uncollected
management fees. Uncollected management fees from
managed investment vehicles were not material at
March 31, 2014, and we have not issued any investment
performance guarantees to these investment vehicles or
their investors. In accordance with financial accounting
standards on consolidation, we consolidate various
sponsored investment vehicles, some of which are
separately identified as CIVs.
45
Legg Mason Certain investment vehicles we sponsor and are the
manager of are considered to be variable interest entities
(“VIEs”) (further described below) while others are
considered to be voting rights entities (“VREs”) subject
to traditional consolidation concepts based on ownership
rights. Investment vehicles that are considered VREs are
consolidated if we have a controlling financial interest in
the investment vehicle, absent substantive investor rights
to replace the manager of the entity (kick-out rights). We
may also fund the initial cash investment in certain VRE
investment vehicles to generate an investment performance
track record in order to attract third-party investors in the
product. These “seed capital investments” are consolidated
as long as Legg Mason maintains a controlling financial
interest in the product, but they are not included as CIVs.
We may also hold a longer-term controlling financial interest
in sponsored investment fund VREs which have third-party
investors and are consolidated and included as CIVs.
A VIE is an entity which does not have adequate equity
to finance its activities without additional subordinated
financial support; or the equity investors, as a group, do
not have the normal characteristics of equity for a potential
controlling financial interest.
Investment Company VIEs
For most sponsored investment funds deemed to be
investment companies, including money market funds, we
determine if we are the primary beneficiary of a VIE if we
absorb a majority of the VIE’s expected losses, or receive a
majority of the VIE’s expected residual returns, if any. Our
determination of expected residual returns excludes gross
fees paid to a decision maker if certain criteria are met. In
determining whether we are the primary beneficiary of
an investment company VIE, we consider 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 us; related party
(including employees’) ownership; guarantees and implied
relationships. In determining the primary beneficiary, we
must make assumptions and estimates about, among other
things, the future performance of the underlying assets held
by the VIE, including investment returns, cash flows, and
credit and interest rate risks. In determining whether a VIE
is significant for disclosure purposes, we consider the same
factors used for determination of the primary beneficiary.
Other VIEs
For other sponsored investment funds that do not meet
the investment company criteria, such as collateralized
debt obligation entities and CLO entities, if we have a
significant variable interest, we determine if we are the
primary beneficiary of the VIE if we have 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. We
determine whether we have a variable interest in a VIE by
considering if, among other things, we have the obligation
to absorb losses, or the right to receive benefits, that are
expected to be significant to the VIE. We consider the
management fee structure, including the seniority level of
our fees, the current and expected economic performance
of the entity, as well as other provisions included in the
governing documents that might restrict or guarantee an
expected loss or residual return.
In evaluating whether we have the obligation to absorb
losses, or the right to receive benefits, that could
potentially be significant to the VIE, we consider factors
regarding the design, terms, and characteristics of the
investment vehicles, including the following qualitative
factors: if we have involvement with the investment
vehicle beyond providing management services; if we
hold equity or debt interests in the investment vehicle;
if we have transferred any assets to the investment
vehicle; if the potential aggregate fees in future periods
are insignificant relative to the potential cash flows
of the investment vehicle; and if the variability of the
expected fees in relation to the potential cash flows of the
investment vehicle is more than insignificant.
We must consolidate any VIE for which we are deemed to
be the primary beneficiary.
See Note 17 of Notes to Consolidated Financial Statements
for additional discussion of CIVs and other VIEs.
Revenue Recognition
The vast majority of our revenues are calculated as a
percentage of the fair value of our AUM. The underlying
securities within the portfolios we manage, which are not
reflected within our consolidated financial statements, are
generally valued as follows: (i) with respect to securities
for which market quotations are readily available, the
market value of such securities; and (ii) with respect to
other securities and assets, fair value as determined in
good faith.
For most of our mutual funds and other pooled products,
their boards of directors or similar bodies are responsible
for establishing policies and procedures related to the
pricing of securities. Each board of directors generally
delegates the execution of the various functions related
to pricing to a fund valuation committee which, in turn,
may rely on information from various parties in pricing
securities such as independent pricing services, the fund
accounting agent, the fund manager, broker-dealers, and
others (or a combination thereof). The funds have controls
46
Legg Mason reasonably designed to ensure that the prices assigned
to securities they hold are accurate. Management
has established policies to ensure consistency in the
application of revenue recognition.
As manager and advisor for separate accounts, we are
generally responsible for the pricing of securities held
in client accounts (or may share this responsibility with
others) and have established policies to govern valuation
processes similar to those discussed above for mutual
funds that are reasonably designed to ensure consistency
in the application of revenue recognition. Management
relies extensively on the data provided by independent
pricing services and the custodians in the pricing of
separate account AUM. Separate account customers
typically select the custodian.
Valuation processes for AUM are dependent on the nature
of the assets and any contractual provisions with our
clients. Equity securities under management for which
market quotations are available are usually valued at the
last reported sales price or official closing price on the
primary market or exchange on which they trade. Debt
securities under management are usually valued at bid, or
the mean between the last quoted bid and asked prices,
provided by independent pricing services that are based
on transactions in debt obligations, quotations from bond
dealers, market transactions in comparable securities and
various other relationships between securities. Short-
term debt obligations are generally valued at amortized
cost, which is designed to approximate fair value. The
vast majority of our AUM is valued based on data from
third parties such as independent pricing services, fund
accounting agents, custodians and brokers. This varies
slightly from time to time based upon the underlying
composition of the asset class (equity, fixed income
and liquidity) as well as the actual underlying securities
in the portfolio within each asset class. Regardless
of the valuation process or pricing source, we have
established controls reasonably designed to assess the
reasonableness of the prices provided. Where market
prices are not readily available, or are determined not to
reflect fair value, value may be determined in accordance
with established valuation procedures based on, among
other things, unobservable inputs. Management fees
on AUM where fair values are based on unobservable
inputs are not material. As of March 31, 2014, equity,
fixed income and liquidity AUM values aggregated $186.4
billion, $365.2 billion and $150.2 billion, respectively.
As the vast majority of our AUM is valued by independent
pricing services based upon observable market prices
or inputs, we believe market risk is the most significant
risk underlying the value of our AUM. Economic events
and financial market turmoil have increased market price
volatility; however, the valuation of the vast majority of
the securities held by our funds and in separate accounts
continues to be derived from readily available market price
quotations. As of March 31, 2014, less than 1% of total
AUM is valued based on unobservable inputs.
Valuation of Financial Instruments
Substantially all financial instruments are reflected in
the financial statements at fair value or amounts that
approximate fair value, except our long-term debt. Trading
investments, investment securities and derivative assets
and liabilities included in the Consolidated Balance Sheets
include forms of financial instruments. Unrealized gains
and losses related to these financial instruments are
reflected in Net Income (Loss) or Other Comprehensive
Income (Loss), depending on the underlying purpose of
the instrument.
For equity investments where we do not control the
investee, and where we are not the primary beneficiary
of a variable interest entity, but can exert significant
influence over the financial and operating policies of the
investee, we follow the equity method of accounting.
The evaluation of whether we exert control or significant
influence over the financial and operational policies of
an investee requires significant judgment based on the
facts and circumstances surrounding each individual
investment. Factors considered in these evaluations may
include investor voting or other rights, any influence we
may have on the governing board of the investee, the legal
rights of other investors in the entity pursuant to the fund’s
operating documents and the relationship between us and
other investors in the entity. Substantially all of our equity
method investees are investment companies which record
their underlying investments at fair value. Therefore,
under the equity method of accounting, our share of the
investee’s underlying net income or loss predominantly
represents fair value adjustments in the investments
held by the equity method investee. Our share of the
investee’s net income or loss is based on the most current
information available and is recorded as a net gain (loss) on
investments within non-operating income (expense).
For investments, we value equity and fixed income
securities using closing market prices for listed
instruments or broker or dealer price quotations, when
available. Fixed income securities may also be valued
using valuation models and estimates based on spreads
to actively traded benchmark debt instruments with
readily available market prices. We evaluate our non-
trading investment securities for “other than temporary”
impairment. Impairment may exist when the fair value of an
investment security has been below the adjusted cost for
an extended period of time. If an “other than temporary”
47
Legg Mason impairment is determined to exist, the difference between
the adjusted cost of the investment security and its current
fair value is recognized as a charge to earnings in the period
in which the impairment is determined.
Level 1—Financial instruments for which prices
are quoted in active markets, which, for us, include
investments in publicly traded mutual funds with quoted
market prices and equities listed in active markets.
For investments in illiquid or privately-held securities for
which market prices or quotations are not readily available,
the determination of fair value requires us to estimate
the value of the securities using a variety of methods and
resources, including the most current available financial
information for the investment and the industry. As of
March 31, 2014 and 2013, excluding investments in CIVs,
we owned approximately $0.3 million and $0.4 million,
respectively, of financial investments that were valued on
our assumptions or estimates and unobservable inputs.
At March 31, 2014 and 2013, we also had approximately
$87.4 million and $99.9 million, respectively, of other
investments, such as investment partnerships, that are
included in Other noncurrent assets on the Consolidated
Balance Sheets, of which approximately $63.0 million and
$68.8 million, respectively, are accounted for under the
equity method. The remainder is accounted for under the
cost method, which considers if factors indicate there
may be an impairment in the value of these investments.
In addition, as of March 31, 2014 and 2013, we had $22.6
million and $56.3 million, respectively, of equity method
investments that are included in Investment securities on
the Consolidated Balance Sheets.
The accounting guidance for fair value measurements and
disclosures defines fair value and establishes a framework
for measuring fair value. The accounting guidance defines
fair value as the exchange price that would be received
for an asset or paid to transfer a liability in the principal
or most advantageous market for the asset or liability in
an orderly transaction between market participants on
the measurement date. A fair value measurement should
reflect all of the assumptions that market participants
would use in pricing the asset or liability, including
assumptions about the risk inherent in a particular
valuation technique, the effect of a restriction on the sale
or use of an asset, and the risk of non-performance.
The accounting guidance for fair value measurements
establishes a hierarchy that prioritizes the inputs for
valuation techniques used to measure fair value. The fair
value hierarchy gives the highest priority to quoted prices
in active markets for identical assets or liabilities and the
lowest priority to unobservable inputs.
Our financial instruments measured and reported at fair value
are classified and disclosed in one of the following categories:
Level 2—Financial instruments for which prices
are quoted for similar assets and liabilities in active
markets; prices are quoted for identical or similar assets
in inactive markets; or prices are based on observable
inputs, other than quoted prices, such as models or
other valuation methodologies. For us, this category
may include repurchase agreements, fixed income
securities and certain proprietary fund products.
This category also includes CLO loans and derivative
liabilities of a CIV.
Level 3—Financial instruments for which values are
based on unobservable inputs, including those for
which there is little or no market activity. This category
includes investments in partnerships, limited liability
companies, private equity funds and CLO debt of a CIV.
This category may also include certain proprietary fund
products with redemption restrictions.
The valuation of an asset or liability may involve inputs from
more than one level of the hierarchy. The level in the fair
value hierarchy within which a fair value measurement in its
entirety falls is determined based on the lowest level input
that is significant to the fair value measurement in its entirety.
Proprietary fund products and certain investments held
by CIVs are valued at net asset value (“NAV”) determined
by the fund administrator. These funds are typically
invested in exchange traded investments with observable
market prices. Their valuations may be classified as
Level 1, Level 2 or Level 3 based on whether the fund
is exchange traded, the frequency of the related NAV
determinations and the impact of redemption restrictions.
For investments in illiquid and privately-held securities
(private equity and investment partnerships) for which
market prices or quotations may not be readily available,
including certain investments held by CIVs, management
must estimate the value of the securities using a variety
of methods and resources, including the most current
available financial information for the investment and the
industry to which it applies in order to determine fair value.
These valuation processes for illiquid and privately-held
securities inherently require management’s judgment and
are therefore classified in Level 3.
The fair values of CLO loans and bonds are determined
based on prices from well-recognized third-party pricing
services that utilize available market data and are therefore
classified as Level 2. Legg Mason has established controls
designed to assess the reasonableness of the prices
48
Legg Mason provided. The fair value of CLO debt is valued using
a discounted cash flow methodology. Inputs used to
determine the expected cash flows include assumptions
about forecasted default and recovery rates that a market
participant would use in determining the fair value of the
CLO’s underlying collateral assets. Given the significance
of the unobservable inputs to the fair value measurement,
the CLO debt valuation is classified as Level 3.
Exchange traded options are valued using the last sale
price or in the absence of a sale, the last offering price.
Options traded over the counter are valued using dealer
supplied valuations. Options are classified as Level 1.
Futures contracts are valued at the last settlement price at
the end of each day on the exchange upon which they are
traded and are classified as Level 1.
As a practical expedient, we rely on the NAVs of certain
investments as their fair value. The NAVs that have been
provided by investees are derived from the fair values of
the underlying investments as of the reporting date.
As of March 31, 2014, approximately 2% of total assets
(11% of financial assets measured at fair value) and 5%
of total liabilities meet the definition of Level 3. Excluding
the assets and liabilities of CIVs, approximately 1% of total
assets (7% of financial assets measured at fair value) and
1% of liabilities meet the definition of Level 3.
Any transfers between categories are measured at the
beginning of the period.
See Note 3 of Notes to Consolidated Financial Statements
for additional information.
Intangible Assets and Goodwill
Balances as of March 31, 2014, are as follows (in
thousands):
Amortizable asset management contracts
Indefinite-life intangible assets
Trade names
Goodwill
$ 9,969
3,109,004
52,800
1,240,523
$4,412,296
Our identifiable intangible assets consist primarily of asset
management contracts, contracts to manage proprietary
mutual funds or funds-of-hedge funds, and trade names
resulting from acquisitions. Asset management contracts
are amortizable intangible assets that are capitalized at
acquisition and amortized over the expected life of the
contract. Contracts to manage proprietary mutual funds or
funds-of-hedge funds are indefinite-life intangible assets
because we assume that there is no foreseeable limit
on the contract period due to the likelihood of continued
renewal at little or no cost. Similarly, trade names are
considered indefinite-life intangible assets because they
are expected to generate cash flows indefinitely.
In allocating the purchase price of an acquisition to
intangible assets, we must determine the fair value of the
assets acquired. We determine fair values of intangible
assets acquired based upon projected future cash flows,
which take into consideration estimates and assumptions
including profit margins, growth or attrition rates for
acquired contracts based upon historical experience,
estimated contract lives, discount rates, projected net
client flows and market performance. The determination
of estimated contract lives requires judgment based
upon historical client turnover and attrition rates and the
probability that contracts with termination provisions will
be renewed. The discount rate employed is a weighted-
average cost of capital that takes into consideration a
premium representing the degree of risk inherent in the
asset, as more fully described below.
Goodwill represents the residual amount of acquisition
cost in excess of identified tangible and intangible assets
and assumed liabilities.
Given the relative significance of our intangible assets
and goodwill to our consolidated financial statements, on
a quarterly basis we consider if triggering events have
occurred that may indicate a significant change in fair
values. Triggering events may include significant adverse
changes in our business, legal or regulatory environment,
loss of key personnel, significant business dispositions, or
other events, including changes in economic arrangements
with our affiliates that will impact future operating results.
If a triggering event has occurred, we perform quantitative
tests, which include critical reviews of all significant factors
and assumptions, to determine if any intangible assets
or goodwill are impaired. We consider factors such as
projected cash flows and revenue multiples, to determine
whether the value of the assets is impaired and the
indefinite-life assumptions are appropriate. If an asset is
impaired, the difference between the value of the asset
reflected on the consolidated financial statements and its
current fair value is recognized as an expense in the period
in which the impairment is determined. If a triggering event
has not occurred, we perform quantitative tests annually
at December 31, for indefinite-life intangible assets and
goodwill, unless we can qualitatively conclude that it is more
likely than not that the respective fair values exceed the
related carrying values.
We completed our annual impairment tests of goodwill
and indefinite-life intangible assets as of December 31,
2013, and determined that there were no impairments
in the value of these assets as of that date. Further, no
49
Legg Mason impairments in the values of amortizable intangible assets
was recognized during the year ended March 31, 2014, as
our estimates of the related future cash flows exceeded
the asset carrying values. We have also determined that
no triggering events have occurred as of March 31, 2014,
therefore, no additional indefinite-life intangible asset and
goodwill impairment testing was necessary. As a result of
uncertainty regarding future market conditions, assessing
the fair value of the reporting unit and intangible assets
requires management to exercise significant judgment.
Amortizable Intangible Assets
Intangible assets subject to amortization are considered
for impairment at each reporting period using an
undiscounted cash flow analysis. Significant assumptions
used in assessing the recoverability of management
contract intangible assets include projected cash
flows generated by the contracts and the remaining
lives of the contracts. Projected cash flows are based
on fees generated by current AUM for the applicable
contracts. Contracts are generally assumed to turnover
evenly throughout the life of the intangible asset. The
remaining life of the asset is based upon factors such as
average client retention and client turnover rates. If the
amortization periods are not appropriate, the expected
lives are adjusted and the impact on the fair value is
assessed. Actual cash flows in any one period may vary
from the projected cash flows without resulting in an
impairment charge because a variance in any one period
must be considered in conjunction with other assumptions
that impact projected cash flows.
The estimated remaining useful lives of amortizable
intangible assets currently range from one to five years
with a weighted-average life of approximately 3.2 years.
Indefinite-Life Intangible Assets
For intangible assets with lives that are indeterminable
or indefinite, fair value is determined from a market
participant’s perspective based on projected discounted
cash flows, taking into account the values market
participants would pay in a taxable transaction to acquire
the respective assets. We have two primary types of
indefinite-life intangible assets: proprietary fund contracts
and, to a lesser extent, trade names.
We determine the fair value of our intangible assets based
upon discounted projected cash flows, which take into
consideration estimates of future fees, profit margins,
growth rates, taxes, and discount rates. An asset is
determined to be impaired if the current implied fair value
is less than the recorded carrying value of the asset.
The determination of the fair values of our indefinite-life
intangible assets is highly dependent on these estimates
and changes in these inputs could result in a material
impairment of the related carrying values. If an asset is
impaired, the difference between the current implied fair
value and the carrying value of the asset reflected on the
financial statements is recognized as an expense in the
period in which the impairment is determined to exist.
Contracts that are managed and operated as a single unit,
such as contracts within the same family of funds, are
reviewed in aggregate and are considered interchangeable
because investors can transfer between funds with
limited restrictions. Similarly, cash flows generated by
new funds added to the fund group are included when
determining the fair value of the intangible asset. The
Fauchier acquisition completed by Permal in March
2013 included a funds-of-hedge fund business, which,
as intended, has been merged with the existing Permal
fund business through common management, shared
resources (including infrastructure, employees and
processes) and co-branding initiatives. Accordingly, the
related carrying values and cash flows of these funds
have been aggregated for impairment testing.
Projected cash flows are based on annualized cash flows
for the applicable contracts projected forward 40 years,
assuming annual cash flow growth from estimated
net client flows and projected market performance. To
estimate the projected cash flows, projected AUM growth
rates by affiliate are used. Cash flow growth rates consider
estimates of both AUM flows and market expectations
by asset class (equity, fixed income and liquidity) and by
investment manager based upon, among other things,
historical experience and expectations of future market
and investment performance from internal and external
sources. Currently, our market growth assumptions are
6% for equity, 3% for fixed income, and 0% for liquidity
products, with a general assumption of 2% organic growth
for all products, subject to exceptions for organic growth
or contraction in near-term periods.
The starting point for these assumptions is our corporate
planning process that includes three-year AUM projections
from the management of each operating affiliate that
consider the specific business circumstances of each
affiliate, with near-year flow assumptions for certain
affiliates adjusted, as appropriate, to reflect a market
participant view. Beyond year three, the estimates move
towards our general organic growth assumption of 2%, as
appropriate for each affiliate and asset class, through year
20. The resulting cash flow growth rate for year 20 is held
constant and used to further project cash flows through
year 40. Based on projected AUM by affiliate and asset
class, affiliate advisory fee rates are applied to determine
projected revenues. The domestic mutual fund contracts
projected revenues are applied to a weighted-average
50
Legg Mason margin for the applicable affiliates that manage the
AUM. Margins are based on arrangements currently in
place at each affiliate. Projected operating income is
further reduced by an appropriate tax rate to calculate the
projected cash flows.
We believe our growth assumptions are reasonable given
our consideration of multiple inputs, including internal and
external sources, although our assumptions are subject
to change based on fluctuations in our actual results and
market conditions. Our assumptions are also subject to
change due to, among other factors, poor investment
performance by one or more of our operating affiliates,
the withdrawal of AUM by clients, changes in business
climate, adverse regulatory actions, or loss of key
personnel. We consider these risks in the development
of our growth assumptions and discount rates, discussed
further below. Further, actual cash flows in any one period
may vary from the projected cash flows without resulting
in an impairment charge because a variance in any one
period must be considered in conjunction with other
assumptions that impact projected cash flows.
Our process includes comparison of actual results to
prior growth projections. However, differences between
actual results and our prior projections are not necessarily
indicative of a need to reassess our estimates given that:
our discounted projected cash flow analyses include
projections well beyond three years and variances in the
near-years may be offset in subsequent years; fair value
assessments are point-in-time, and the consistency of
a fair value assessment with other indicators of value
that reflect expectations of market participants at that
point-in-time is critical evidence of the soundness of the
estimate of value. In subsequent periods, we consider
the differences in actual results from our prior projections
in considering the reasonableness of the growth
assumptions used in our current impairment testing.
Discount rates are based on appropriately weighted
estimated costs of debt and equity capital using a market
participant perspective. We estimate the cost of debt based
on published debt rates. We estimate the cost of equity
capital based on the Capital Asset Pricing Model, which
considers the risk-free interest rate, peer-group betas,
and company and equity risk premiums. The equity risk is
further adjusted to consider the relative risk associated with
each Legg Mason indefinite-life intangible asset and our
reporting unit. The discount rates are also calibrated based
on an assessment of relevant market values.
Consistent with standard valuation practices for taxable
transactions, the projected discounted cash flow analysis
also factors in a tax benefit value, as appropriate. This tax
benefit represents the discounted tax savings a third party
that purchased an asset on a given valuation date would
receive from future tax deductions for the amortization of
the purchase price over 15 years.
The domestic mutual fund contracts acquired in the
Citigroup Asset Management (“CAM”) transaction of
$2,106 million, account for approximately 65% of our
indefinite-life intangible assets. As of December 31, 2013,
approximately $138 billion of AUM, primarily managed
by ClearBridge and Western Asset, are associated with
this asset, with approximately 40% in equity AUM
and 30% in each of long-term fixed AUM and liquidity
AUM. Although our domestic mutual funds overall have
maintained strong recent market performance, previously
disclosed uncertainties regarding market conditions and
asset flows and more recent assessments of related risk,
including risks related to potential regulatory changes
in the liquidity business, are reflected in our projected
discounted cash flow analyses. Based on our projected
discounted cash flow analyses, the related fair value
exceeded its carrying value by approximately $450 million.
For our impairment test, cash flows from the domestic
mutual fund contracts are assumed to have annual growth
rates that average approximately 6%, but given current
uncertainties, reflect only moderate AUM inflows in years
1 and 2. Projected cash flows of the domestic mutual fund
contracts are discounted at 14.0%, reflecting the business
factors noted above. Results for the 12 months through
December 31, 2013, generally compared favorably to the
growth assumptions related to the domestic mutual fund
contracts asset impairment testing at December 31, 2012.
We believe that investment performance also has a
significant influence on our domestic mutual fund contract
long-term flows, and that continued out-performance
will favorably impact our flows. In aggregate, 61% of our
domestic mutual fund long-term AUM is in funds that
have outpaced their three-year Lipper category average
at December 31, 2013, which has improved from 33% at
September 30, 2008. Generally, there tends to be a four
to five-year lag before improved investment performance
results in increased asset flows. In addition, we believe
a recent reorganization of our distribution platform,
which provides an improved focus on the growth of our
business, has also favorably impacted our flows. The
improvement in investment performance has assisted
distribution personnel in selling more products. As a result
of improved performance and the reorganization of the
distribution platform, our U.S. distribution group has had
net inflows for the 12 months through December 31, 2013.
Assuming all other factors remain the same, our actual
results and/or changes in assumptions for the domestic
51
Legg Mason mutual fund contracts cash flow projections over the long-
term would have to deviate approximately 20% or more
from previous projections, or the discount rate would have
to be raised from 14.0% to 16.0%, for the asset to be
deemed impaired. Given the current uncertainty regarding
future market conditions, it is reasonably possible that
fund performance, flows and AUM levels may decrease
in the near term such that actual cash flows from the
domestic mutual funds contracts could deviate from the
projections by approximately 20% or more and the asset
could be deemed to be impaired by a material amount.
The Permal funds-of-hedge funds contracts of $692
million account for approximately 20% of our indefinite-life
intangible assets. Permal has experienced recent outflows
and increased risk associated with its business. The past
several years have seen declines in the traditional high
net worth client fund-of-hedge funds business, Permal’s
historical focus, which Permal has offset to some extent
with new institutional business. Despite these factors,
the impact of the acquired Fauchier business, which has
experienced better revenues, including performance fees,
than originally projected, contributed to actual results
which marginally exceeded previous projections for the
Permal funds-of-hedge funds contracts used in the asset
impairment testing at December 31, 2012. As a result of
continued risk with its business, in our December 2013
testing, the near-term growth assumptions for these
contracts were reduced. Further, fund-of-hedge fund
managers are subject to unique market and regulatory
influences, adding additional uncertainty to our estimates.
Based upon our projected discounted cash flow analyses,
the fair value of the Permal funds-of-hedge funds
contracts asset exceeded its carrying value by $70 million.
Cash flows on the Permal funds-of-hedge funds contracts
are assumed to have an average annual growth rate of
approximately 7%. However, given current experience,
projected cash flows reflect moderate AUM outflows in
year one, and no net AUM flows in year two, trending
to moderate AUM inflows in year three. Investment
performance, including its expected impact on future asset
flows, is a significant factor in our growth projections for
the Permal funds-of-hedge funds contracts. Our market
performance projections are supported by the fact that
Permal’s two largest funds that comprise approximately
half of the contracts asset AUM have 10-year average
returns exceeding 5%. Our market projections are further
supported by industry statistics. The projected cash flows
from the Permal funds-of-hedge funds contracts are
discounted at 15.5%, reflecting the factors noted above.
Assuming all other factors remain the same, our actual
results and/or changes in assumptions for the Permal
funds-of-hedge funds contracts cash flow projections over
the long-term would have to deviate approximately 10% or
more from previous projections, or the discount rate would
have to be raised from 15.5% to 16.5%, for the asset to be
deemed impaired. Given the current uncertainty regarding
future market conditions, it is reasonably possible that
fund performance, flows and AUM levels may decrease in
the near term such that actual cash flows from the Permal
funds-of-hedge funds contracts could deviate from the
projections by approximately 10% or more and the asset
could be deemed to be impaired by a material amount.
Trade names account for 2% of indefinite-life intangible
assets and are primarily related to Permal. We tested
these intangible assets using assumptions similar to those
described above for indefinite-life contracts. The resulting
fair values of the trade names significantly exceeded the
related carrying amounts.
Goodwill
Goodwill is evaluated at the reporting unit level and is
considered for impairment when the carrying amount of the
reporting unit exceeds the implied fair value of the reporting
unit. In estimating the implied fair value of the reporting
unit, we use valuation techniques based on discounted
projected cash flows and EBITDA multiples, similar to
techniques employed in analyzing the purchase price of an
acquisition. Legg Mason continues to be managed as one
Global Asset Management operating segment. Internal
management reporting of discrete financial information
regularly received by the chief operating decision maker,
our Chief Executive Officer, is at the consolidated Global
Asset Management business level. As a result, goodwill is
recorded and evaluated at one Global Asset Management
reporting unit level. Our Global Asset Management
reporting unit consists of the operating businesses of
our asset management affiliates and our centralized
global distribution operations. In our impairment testing
process, all consolidated assets (except for certain tax
benefits) and liabilities are allocated to our single Global
Asset Management reporting unit. Similarly, the projected
operating results of the reporting unit include our holding
company corporate costs and overhead, including costs
associated with executive management, finance, human
resources, legal and compliance, internal audit and other
central corporate functions.
Goodwill principally originated from the acquisitions of
CAM, Permal and Royce. The value of the reporting unit
is based in part, on projected consolidated net cash flows,
including all cash flows of assets managed in our mutual
52
Legg Mason funds, closed-end funds and other proprietary funds, in
addition to separate account assets of our managers.
Significant assumptions used in assessing the implied fair
value of the reporting unit under the discounted cash flow
method are consistent with the methodology discussed
above for indefinite-life intangible assets. Also, at the
reporting unit level, future corporate costs are estimated
and consolidated with the projected operating results of all
our affiliates.
Actual cash flows in any one period may vary from the
projected cash flows without resulting in an impairment
charge because a variance in any one period must be
considered in conjunction with other assumptions that
impact projected cash flows. For the reporting unit
discounted projected cash flow analysis, projected cash
flows, on an aggregate basis across all asset classes,
are assumed to have an average annual growth rate of
approximately 8%.
Discount rates are based on appropriately weighted
estimated costs of debt using a market participant
perspective, also consistent with the methodology
discussed above for indefinite-life intangible assets.
For our impairment test as of December 31, 2013, the
projected cash flows were discounted at 14.5% to
determine their present value, reflecting the company/
asset specific factors noted above.
We also perform a market-based valuation of our
reporting unit value, which applies an average of EBITDA
multiples paid in change of control transactions for peer
companies to our EBITDA. The observed average EBITDA
multiple utilized was 11.0x, from 11 asset management
transactions dated January 2010 through December
2012. The results of our two estimates of value for the
reporting unit (the discounted cash flow and EBITDA
multiple analyses) are compared and any significant
difference is assessed to determine the reasonableness
of each value and whether any adjustment to either
result is warranted. Once the values are accepted, the
appropriately weighted average of the two reporting unit
valuations (the discounted cash flow and EBITDA multiple
analyses) is used as the implied fair value of our Global
Asset Management reporting unit, which at December 31,
2013, exceeded the carrying value by a material amount.
Considering the relative merits of the details involved in
each valuation process, we used an equal weighting of the
two values for the December 2013 testing.
We further assess the accuracy of the reporting unit value
determined from these valuation methods by comparing
their results to our market capitalization to determine
an implied control premium. The reasonableness of this
implied control premium is considered by comparing it to
control premiums that have been paid in relevant actual
change of control transactions. This assessment provides
evidence that our underlying assumptions in our analyses
of our reporting unit fair value are reasonable.
In calculating our market capitalization for these purposes,
market volatility can have a significant impact on our
capitalization, and if appropriate, we may consider the
average market prices of our stock for a period of one
or two months before the test date to determine market
capitalization. A control premium arises from the fact
that in an acquisition, there is typically a premium paid
over current market prices of publicly traded companies
that relates to the ability to control the operations of
an acquired company. Further, assessments of control
premiums in the asset management industry are
difficult because many acquisitions involve privately held
companies, or involve only portions of a public company,
such that no control premium can be calculated. Asset
manager transactions are often valued on EBITDA
multiples which, absent unusual circumstances, have
generally been consistently priced in a range of 8x to 13x
EBITDA over the past several years.
Recent market evidence regarding control premiums
suggest values of 13% to 79% as realistic and common
and we believe such premiums to be a reasonable range
of estimation for our equity value. Based on our analysis
and consideration, we believe the implied control premium
determined by our reporting unit value estimation at
December 31, 2013, which is at the lower end of the
observed range, is reasonable.
Stock-Based Compensation
Our stock-based compensation plans include stock
options, an employee stock purchase plan, market-based
performance shares payable in common stock, restricted
stock awards and units, management equity plans and
deferred compensation payable in stock. Under our stock
compensation plans, we issue equity awards to directors,
officers, and key employees.
In accordance with the applicable accounting guidance,
compensation expense for the years ended March 31,
2014, 2013 and 2012, includes compensation cost for all
non-vested share-based awards at their grant date fair
value amortized over the respective vesting periods on the
straight-line method. Also, under the accounting guidance,
cash flows related to income tax deductions in excess of
or less than the stock-based compensation expense are
classified as financing cash flows.
We granted 1.2 million, 1.0 million, and 0.8 million stock
options in fiscal 2014, 2013 and 2012, respectively. During
53
Legg Mason fiscal 2014, we also implemented management equity
plans for two of our affiliates and granted units to certain
of their employees that entitle them to participate in 15%
of the future growth of the respective affiliate’s enterprise
value (subject to appropriate discounts). For additional
information on share-based compensation, see Note 11 of
Notes to Consolidated Financial Statements.
We determine the fair value of each option grant using
the Black-Scholes option-pricing model, except for
market-based grants, for which we use a Monte Carlo
option-pricing model. Both models require management
to develop estimates regarding certain input variables. The
inputs for the Black-Scholes model include: stock price
on the date of grant, exercise price of the option, dividend
yield, volatility, expected life and the risk-free interest
rate, all of which, with the exception of the grant date
stock price and the exercise price, require estimates or
assumptions. We calculate the dividend yield based upon
the average of the historical quarterly dividend payments
over a term equal to the expected life of the options. We
estimate volatility equally weighted between the historical
prices of our stock over a period equal to the expected
life of the option and the implied volatility of market listed
options at the date of grant. The expected life is the
estimated length of time an option will be held before it
is either exercised or canceled, based upon our historical
option exercise experience. The risk-free interest rate is the
rate available for zero-coupon U.S. Government issues with
a remaining term equal to the expected life of the options
being valued. If we used different methods to estimate our
variables for the Black-Scholes and Monte Carlo models, or
if we used a different type of option-pricing model, the fair
value of our option grants might be different.
We also determine the fair value of affiliate management
equity plan grants using the Black-Scholes option-pricing
model, subject to any post-vesting illiquidity discounts.
Inputs to the Black-Scholes model are generally
determined in a fashion similar to the fair value of grants
of options in our own stock, described above. However,
because our affiliates are private companies without
quoted stock prices, we utilize discounted cash flow
analyses and market-based valuations, similar to those
discussed above under the heading “Intangible Assets
and Goodwill,” to determine the respective business
enterprise values, subject to appropriate discounts for lack
of control and marketability.
Income Taxes
We are subject to the income tax laws of the federal,
state and local jurisdictions of the U.S. and numerous
foreign jurisdictions in which we operate. We file income
tax returns representing our filing positions with each
jurisdiction. Due to the inherent complexities arising from
conducting business and being taxed in a substantial
number of jurisdictions, we must make certain estimates
and judgments in determining our income tax provision for
financial statement purposes.
These estimates and judgments are used in determining
the tax basis of assets and liabilities and in the
calculation of certain tax assets and liabilities that arise
from differences in the timing of revenue and expense
recognition for tax and financial statement purposes.
Management assesses the likelihood that we will be able
to realize our deferred tax assets. If it is more likely than
not that the deferred tax asset will not be realized, then a
valuation allowance is established with a corresponding
increase to deferred tax provision.
Substantially all of our deferred tax assets relate to U.S. and
U.K. taxing jurisdictions. As of March 31, 2014, U.S. federal
deferred tax assets aggregated $763 million, realization
of which is expected to require $3.8 billion of future U.S.
earnings, approximately $673 million of which must be in
the form of foreign source income. Deferred tax assets
generated in U.S. jurisdictions resulting from net operating
losses generally expire 20 years after they are generated
and those resulting from foreign tax credits generally expire
10 years after they are generated. Based on estimates of
future taxable income, using assumptions consistent with
those used in our goodwill impairment testing, it is more
likely than not that current federal tax benefits relating
to net operating losses are realizable and no valuation
allowance is necessary at this time. With respect to those
resulting from foreign tax credits, it is more likely than
not that tax benefits relating to the utilization of $39.9
million foreign tax credits as credits will not be realized
and an additional valuation allowance of $2.3 million was
recorded in fiscal 2014 with respect thereto. In addition, a
valuation allowance was established in prior years for the
substantial portion of our deferred tax assets relating to
U.K. taxing jurisdictions. While tax planning may enhance
our positions, the realization of current tax benefits is not
dependent on any significant tax strategies.
As of March 31, 2014, U.S. state deferred tax assets
aggregated $180 million. Due to limitations on the
utilization of net operating loss carryforwards and taking
into consideration state tax planning strategies, we
recognized an additional valuation allowance of $8.6
million during fiscal 2014. Additionally, $34.8 million of fully
reserved deferred tax assets relating to U.S. state capital
loss carryforwards expired unused during fiscal 2014. Due
to the uncertainty of future state apportionment factors
and future effective state tax rates, the value of state net
operating loss benefits ultimately realized may vary.
54
Legg Mason An increase in the valuation allowance against certain U.K.
deferred tax assets of $0.5 million, which resulted in a full
valuation allowance, was also recorded in fiscal 2014. To
the extent our analysis of the realization of deferred tax
assets relies on deferred tax liabilities, we have considered
the timing, nature and jurisdiction of reversals, as well
as, future increases relating to the tax amortization of
goodwill and indefinite-life intangible assets. In the event
we determine all or any portion of our deferred tax assets
that are not already subject to a valuation allowance are
not realizable, we will be required to establish a valuation
allowance by a charge to the income tax provision in the
period in which that determination is made. Depending on
the facts and circumstances, the charge could be material
to our earnings.
The calculation of our tax liabilities involves uncertainties in
the application of complex tax regulations. We recognize
liabilities for anticipated tax uncertainties in the U.S. and
other tax jurisdictions based on our estimate of whether,
and the extent to which, additional taxes will be due.
RECENT ACCOUNTING DEVELOPMENTS
See discussion of Recent Accounting Developments in
Note 1 of Notes to Consolidated Financial Statements.
EFFECTS OF INFLATION
The rate of inflation can directly affect various expenses,
including employee compensation, communications
and technology and occupancy, which may not be
readily recoverable in charges for services provided by
us. Further, to the extent inflation adversely affects the
securities markets, it may impact revenues and recorded
intangible asset and goodwill values. See discussion of
“Market Risk—Revenues and Net Income (Loss)” and
“Critical Accounting Policies—Intangible Assets and
Goodwill” previously discussed.
55
Legg Mason Report of Management on Internal Control over Financial Reporting
The management of Legg Mason, Inc. is responsible for establishing and maintaining adequate internal control over
financial reporting.
Legg Mason’s internal control over financial reporting is a process designed to provide reasonable assurance regarding
the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with
accounting principles generally accepted in the United States of America. Legg Mason’s internal control over financial
reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and dispositions of the assets of Legg Mason; (ii) provide reasonable
assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with
accounting principles generally accepted in the United States of America, and that receipts and expenditures of Legg
Mason are being made only in accordance with authorizations of management and directors of Legg Mason; and (iii)
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of
Legg Mason’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of Legg Mason’s internal control over financial reporting as of March 31,
2014, based on the framework set forth by the Committee of Sponsoring Organizations of the Treadway Commission
(“COSO”) in Internal Control—Integrated Framework (1992). Based on that assessment, management concluded that, as
of March 31, 2014, Legg Mason’s internal control over financial reporting is effective based on the criteria established in
the COSO framework.
The effectiveness of Legg Mason’s internal control over financial reporting as of March 31, 2014, has been audited by
PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report appearing
herein, which expresses an unqualified opinion on the effectiveness of Legg Mason’s internal control over financial
reporting as of March 31, 2014.
Joseph A. Sullivan
President, Chief Executive Officer and Director
Peter H. Nachtwey
Senior Executive Vice President and Chief Financial Officer
56
Legg Mason
Report of Independent Registered Public Accounting Firm
To the Board of Directors
and Stockholders of Legg Mason, Inc.:
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income (loss),
comprehensive income (loss), changes in stockholders’ equity and cash flows present fairly, in all material respects,
the financial position of Legg Mason, Inc. and its subsidiaries (“the Company”) at March 31, 2014 and March 31, 2013,
and the results of their operations and their cash flows for each of the three years in the period ended March 31, 2014
in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the
Company maintained, in all material respects, effective internal control over financial reporting as of March 31, 2014,
based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial
statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness
of internal control over financial reporting, included in the accompanying Report of Management on Internal Control over
Financial Reporting. Our responsibility is to express opinions on these financial statements and on the Company's internal
control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards
of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform
the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement
and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the
financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates made by management, and evaluating
the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an
understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing
and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also
included performing such other procedures as we considered necessary in the circumstances. We believe that our audits
provide a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding
the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. A company’s internal control over financial reporting includes those policies
and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect
the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the company are being made only in accordance with authorizations
of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the
financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Baltimore, Maryland
May 23, 2014
57
Legg Mason Consolidated Balance Sheets
(Dollars in thousands)
ASSETS
Current Assets
Cash and cash equivalents
Cash and cash equivalents of consolidated investment vehicles
Restricted cash
Receivables:
Investment advisory and related fees
Other
Investment securities
Investment securities of consolidated investment vehicles
Deferred income taxes
Other
Other assets of consolidated investment vehicles
Total Current Assets
Fixed assets, net
Intangible assets, net
Goodwill
Investments of consolidated investment vehicles
Deferred income taxes
Other
Other assets of consolidated investment vehicles
Total Assets
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities
Current Liabilities
Accrued compensation
Accounts payable and accrued expenses
Current portion of long-term debt
Other
Debt and other current liabilities of consolidated investment vehicles
Total Current Liabilities
Deferred compensation
Deferred income taxes
Other
Other liabilities of consolidated investment vehicles
Long-term debt
Long-term debt of consolidated investment vehicles
Total Liabilities
Commitments and Contingencies (Note 8)
Redeemable Noncontrolling Interests
Stockholders’ Equity
Common stock, par value $.10; authorized 500,000,000 shares;
issued 117,173,639 shares in 2014 and 125,341,361 shares in 2013
Additional paid-in capital
Employee stock trust
Deferred compensation employee stock trust
Retained earnings
Appropriated retained earnings for consolidated investment vehicle
Accumulated other comprehensive income, net
Total Stockholders’ Equity
Total Liabilities and Stockholders’ Equity
See Notes to Consolidated Financial Statements.
58
March 31,
2014
2013
$ 858,022
56,372
13,455
$ 933,036
46,541
8,812
348,633
68,186
467,726
50,463
186,147
47,677
31,702
2,128,383
189,241
3,171,773
1,240,523
31,810
165,705
183,706
208
$7,111,349
$ 425,466
214,819
438
91,586
88,936
821,245
49,618
265,583
166,209
—
1,038,826
—
2,341,481
350,726
72,392
371,080
24,792
85,257
48,239
1,987
1,942,862
201,819
3,177,562
1,269,165
210,553
279,361
187,274
1,064
$7,269,660
$ 351,965
214,803
50,438
74,940
10,320
702,466
56,809
161,298
204,446
2,930
1,094,516
207,835
2,430,300
45,144
21,009
11,717
3,148,396
(29,922)
29,922
1,526,662
—
37,949
4,724,724
$7,111,349
12,534
3,449,190
(32,623)
32,623
1,304,259
4,829
47,539
4,818,351
$7,269,660
Legg Mason Consolidated Statements of Income (Loss)
(Dollars in thousands, except per share amounts)
OPERATING REVENUES
Investment advisory fees:
Separate accounts
Funds
Performance fees
Distribution and service fees
Other
Total Operating Revenues
OPERATING EXPENSES
Compensation and benefits
Transition-related compensation
Total Compensation and Benefits
Distribution and servicing
Communications and technology
Occupancy
Amortization of intangible assets
Impairment of intangible assets
Other
Total Operating Expenses
OPERATING INCOME (LOSS)
Years Ended March 31,
2014
2013
2012
$ 777,420 $ 730,326
$ 775,534
1,501,278
1,446,066
1,491,325
107,087
347,598
8,374
98,568
330,480
7,210
49,499
340,966
5,250
2,741,757
2,612,650
2,662,574
1,210,387
1,188,470
1,109,671
—
—
34,638
1,210,387
1,188,470
1,144,309
619,070
157,872
115,234
12,314
600,644
149,645
171,941
14,019
— 734,000
649,739
164,712
154,816
19,574
—
195,987
188,430
190,671
2,310,864
3,047,149
2,323,821
430,893
(434,499)
338,753
OTHER NON-OPERATING INCOME (EXPENSE)
Interest income
Interest expense
Other income (expense), net, including $68,975 debt extinguishment loss in 2013
Other non-operating income (loss) of consolidated investment vehicles, net
Total Other Non-Operating Income (Expense)
INCOME (LOSS) BEFORE INCOME TAX PROVISION (BENEFIT)
Income tax provision (benefit)
NET INCOME (LOSS)
6,367
(52,911)
32,818
2,474
(11,252)
419,641
137,805
281,836
7,590
(62,919)
(17,958)
(2,821)
(76,108)
(510,607)
(150,859)
(359,748)
Less: Net income (loss) attributable to noncontrolling interests
(2,948)
(6,421)
11,481
(87,584)
22,097
18,336
(35,670)
303,083
72,052
231,031
10,214
NET INCOME (LOSS) ATTRIBUTABLE TO LEGG MASON, INC.
$ 284,784 $ (353,327) $ 220,817
NET INCOME (LOSS) PER SHARE ATTRIBUTABLE TO LEGG MASON, INC.
COMMON SHAREHOLDERS
Basic
Diluted
See Notes to Consolidated Financial Statements.
$
$
2.34 $
(2.65) $
1.54
2.33 $
(2.65) $
1.54
59
Legg Mason
Consolidated Statements of Comprehensive Income (Loss)
(Dollars in thousands)
NET INCOME (LOSS)
Other comprehensive income (loss):
Foreign currency translation adjustment
Unrealized gains (losses) on investment securities:
Unrealized holding gains (losses), net of tax provision (benefit) of
$(123), $(1) and $132, respectively
Reclassification adjustment for losses included in net income (loss)
Net unrealized gains (losses) on investment securities
Total other comprehensive income (loss)
COMPREHENSIVE INCOME (LOSS)
Less: Comprehensive income (loss) attributable to noncontrolling interests
Years Ended March 31,
2014
2013
2012
$281,836
$(359,748)
$231,031
(9,424)
(23,945)
(22,098)
(184)
18
(166)
(1)
13
12
(9,590)
(23,933)
272,246
(383,681)
(2,948)
(6,421)
198
11
209
(21,889)
209,142
10,214
COMPREHENSIVE INCOME (LOSS) ATTRIBUTABLE TO LEGG MASON, INC.
$275,194
$(377,260)
$198,928
See Notes to Consolidated Financial Statements.
60
Legg Mason Consolidated Statements of Changes in Stockholders’ Equity
(Dollars in thousands)
COMMON STOCK
Beginning balance
Stock options and other stock-based compensation
Deferred compensation employee stock trust
Deferred compensation, net
Equity Units exchanged
Employee tax withholdings by settlement of net share transactions
Shares repurchased and retired
Ending balance
ADDITIONAL PAID-IN CAPITAL
Beginning balance
Stock options and other stock-based compensation
Deferred compensation employee stock trust
Deferred compensation, net
Equity Units exchanged
Employee tax withholdings by settlement of net share transactions
Shares repurchased and retired
Redeemable noncontrolling interest for management equity plan
Allocation from 2.5% Convertible Senior Notes repurchase, net of tax
Ending balance
EMPLOYEE STOCK TRUST
Beginning balance
Shares issued to plans
Distributions and forfeitures
Ending balance
DEFERRED COMPENSATION EMPLOYEE STOCK TRUST
Beginning balance
Shares issued to plans
Distributions and forfeitures
Ending balance
RETAINED EARNINGS
Beginning balance
Net income (loss) attributable to Legg Mason, Inc.
Dividends declared
Ending balance
APPROPRIATED RETAINED EARNINGS FOR CONSOLIDATED INVESTMENT VEHICLE
Beginning balance
Net income (loss) reclassified to appropriated retained earnings
Ending balance
ACCUMULATED OTHER COMPREHENSIVE INCOME, NET
Beginning balance
Net unrealized holding gains (losses) on investment securities
Foreign currency translation adjustment
Ending balance
TOTAL STOCKHOLDERS’ EQUITY
See Notes to Consolidated Financial Statements.
Years Ended March 31,
2014
2013
2012
$
12,534
$
13,987
$
15,022
83
5
118
—
(55)
8
8
192
—
(41)
17
7
124
183
(6)
(968)
11,717
(1,620)
12,534
(1,360)
13,987
3,449,190
3,864,216
4,111,095
29,537
1,779
48,143
—
5,198
1,803
44,246
16,508
2,020
32,193
—
102,831
(19,409)
(11,303)
(1,525)
(359,028)
(423,855)
(398,906)
(1,816)
—
—
(31,115)
—
—
3,148,396
3,449,190
3,864,216
(32,623)
(32,419)
(34,466)
(1,784)
4,485
(1,811)
1,607
(2,027)
4,074
(29,922)
(32,623)
(32,419)
32,623
1,784
(4,485)
29,922
32,419
1,811
(1,607)
32,623
34,466
2,027
(4,074)
32,419
1,304,259
1,715,395
1,539,984
284,784
(62,381)
(353,327)
(57,809)
220,817
(45,406)
1,526,662
1,304,259
1,715,395
4,829
(4,829)
—
47,539
(166)
(9,424)
37,949
12,221
(7,392)
4,829
71,472
12
(23,945)
47,539
10,922
1,299
12,221
93,361
209
(22,098)
71,472
$4,724,724
$4,818,351
$5,677,291
61
Legg Mason Consolidated Statements of Cash Flows
(Dollars in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income (Loss)
2.5% Convertible Senior Notes:
Allocation of repurchase payment
Loss on extinguishment
Adjustments to reconcile Net Income (Loss) to net cash provided by operations:
Impairment of intangible assets
Depreciation and amortization
Imputed interest for 2.5% Convertible Senior Notes
Accretion and amortization of securities discounts and premiums, net
Stock-based compensation
Net gains on investments
Net losses (gains) of consolidated investment vehicles
Deferred income taxes
Other
Decrease (increase) in assets:
Investment advisory and related fees receivable
Net sales (purchases) of trading and other current investments
Other receivables
Other assets
Other assets of consolidated investment vehicles
Increase (decrease) in liabilities:
Accrued compensation
Deferred compensation
Accounts payable and accrued expenses
Other liabilities
Other liabilities of consolidated investment vehicles
CASH PROVIDED BY OPERATING ACTIVITIES
CASH FLOWS FROM INVESTING ACTIVITIES
Payments for fixed assets
Acquisitions/dispositions
Change in restricted cash
Purchases of investment securities
Proceeds from sales and maturities of investment securities
Purchases of investments by consolidated investment vehicles
Proceeds from sales and maturities of investments by consolidated investment vehicles
Years Ended March 31,
2014
2013
2012
$281,836
$(359,748)
$ 231,031
—
—
—
62,845
—
3,037
66,488
(26,805)
(643)
118,430
3,276
(2,061)
(44,293)
14,105
(24,042)
(62,916)
76,968
(7,191)
319
(18,310)
(3,719)
437,324
(40,452)
1,351
(5,801)
(4,335)
4,306
(17,328)
199,886
(216,038)
68,975
734,000
87,848
5,839
3,295
58,983
(43,684)
5,358
(157,355)
1,725
(11,045)
189,347
(9,712)
(1,605)
(14,378)
(54,964)
(530)
8,690
3,112
5,219
—
—
—
93,795
39,077
4,552
48,735
(1,714)
(6,711)
49,192
(12,191)
31,790
(40,020)
1,432
1,810
53,720
42,763
(35,148)
(11,147)
28,135
(22,332)
303,332
496,769
(38,351)
(55,277)
(7,245)
(5,787)
5,272
(31,822)
3,060
11,221
(6,493)
6,197
(98,374)
(141,727)
188,739
161,894
CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES
$137,627
$ (11,023)
$ 2,330
See Notes to Consolidated Financial Statements.
62
Legg Mason Consolidated Statements of Cash Flows (continued)
(Dollars in thousands)
CASH FLOWS FROM FINANCING ACTIVITIES
Repayment of short-term borrowings
Years Ended March 31,
2014
2013
2012
$
— $ (250,000)
$
—
Repayment of 2.5% Convertible Senior Notes, net of operating allocation
— (1,040,212)
(1,014)
Repayment of long-term debt
Repayment of long-term debt of consolidated investment vehicles
Proceeds from issuance of long-term debt
Debt issuance costs
Issuance of common stock for stock-based compensation
Employee tax withholdings by settlement of net share transactions
Repurchase of common stock
Dividends paid
Net repayments of consolidated investment vehicles
Net (redemptions/distributions paid to)/subscriptions received from
noncontrolling interest holders
CASH USED IN FINANCING ACTIVITIES
EFFECT OF EXCHANGE RATES ON CASH
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR
CASH AND CASH EQUIVALENTS AT END OF YEAR
SUPPLEMENTAL DISCLOSURE
Cash paid for:
(500,439)
(133,047)
(9,006)
(75,561)
393,740
1,143,246
(3,940)
25,603
(19,464)
(10,289)
1,986
(11,302)
—
—
—
—
4,538
—
(359,996)
(425,516)
(401,797)
(61,966)
(55,250)
—
—
(43,602)
(18,309)
20,438
(3,993)
(21,596)
(639,071)
(735,897)
(481,780)
(10,894)
(75,014)
(5,639)
(449,227)
(10,974)
6,345
933,036
1,382,263
1,375,918
$ 858,022
$ 933,036
$1,382,263
Income taxes, net of refunds of $(13,835), $(2,313), and $(12,034), respectively
$ 10,140
$
32,318
$
24,552
Interest
44,295
40,262
41,039
See Notes to Consolidated Financial Statements.
63
Legg Mason
Notes to Consolidated Financial Statements
(Amounts in thousands, except per share amounts or unless otherwise noted)
1. SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES
Basis of Presentation
Legg Mason, Inc. (“Parent”) and its subsidiaries
(collectively, “Legg Mason”) are principally engaged in
providing asset management and related financial services
to individuals, institutions, corporations and municipalities.
The consolidated financial statements include the
accounts of the Parent and its subsidiaries in which it
has a controlling financial interest. Generally, an entity is
considered to have a controlling financial interest when it
owns a majority of the voting interest in an entity. Legg
Mason is also required to consolidate any variable interest
entity (“VIE”) in which it is considered to be the primary
beneficiary. See “Consolidation” below and Note 17 for
a further discussion of VIEs. All material intercompany
balances and transactions have been eliminated.
Certain amounts in prior year financial statements have been
reclassified to conform to the current year presentation.
All references to fiscal 2014, 2013 or 2012, refer to Legg
Mason’s fiscal year ended March 31 of that year.
Use of Estimates
The consolidated financial statements are prepared in
accordance with accounting principles generally accepted
in the United States of America (“U.S.”) and the applicable
rules and regulations of the Securities and Exchange
Commission (the “SEC”), which require management to
make assumptions and estimates that affect the amounts
reported in the financial statements and accompanying
notes, including revenue recognition, valuation of financial
instruments, intangible assets and goodwill, stock-
based compensation, income taxes, and consolidation.
Management believes that the estimates used are
reasonable, although actual amounts could differ from
the estimates and the differences could have a material
impact on the consolidated financial statements.
Consolidation
In the normal course of its business, Legg Mason
sponsors and is the manager of various types of
investment vehicles. For its services, Legg Mason is
entitled to receive management fees and may be eligible,
under certain circumstances, to receive additional
subordinated 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. Legg Mason did not sell or transfer
assets to any of these investment vehicles. In accordance
with financial accounting standards on consolidation,
Legg Mason consolidates and separately identifies
certain sponsored investment vehicles as consolidated
investment vehicles (“CIVs”), 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 Net Income (Loss), net of amounts allocated to
noncontrolling interests.
Certain investment vehicles Legg Mason sponsors and
is the manager of are considered to be VIEs (further
described below) while others are considered to be voting
rights entities (“VREs”) subject to traditional consolidation
concepts based on ownership rights. Investment vehicles
that are considered VREs are consolidated if Legg Mason
has a controlling financial interest in the investment
vehicle, absent substantive investor rights to replace
the manager of the entity (kick-out rights). Legg Mason
may also fund the initial cash investment in certain
VRE investment vehicles to generate an investment
performance track record in order to attract third-party
investors in the product. Legg Mason’s initial investment in
a new product typically represents 100% of the ownership
in that product. As further discussed below, these “seed
capital investments” are consolidated as long as Legg
Mason maintains a controlling financial interest in the
product, but they are not included as CIVs unless Legg
Mason’s investment is longer term. Legg Mason held a
longer-term controlling financial interest in one sponsored
investment fund VRE, which has third-party investors and
was consolidated and included as a CIV as of March 31,
2014, 2013 and 2012.
A VIE is an entity which does not have adequate equity
to finance its activities without additional subordinated
financial support; or the equity investors, as a group, do
not have the normal characteristics of equity for a potential
controlling financial interest.
Investment Company VIEs
For most sponsored investment funds deemed to be
investment companies, 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 an investment company VIE, Legg
Mason considers both qualitative and quantitative factors
64
Legg Mason 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 (including employees’)
ownership; guarantees and implied relationships.
Legg Mason concluded it was the primary beneficiary
of one sponsored investment fund VIE, which was
consolidated (and designated a CIV) as of March 31, 2014,
2013 and 2012, despite significant third party investments
in this product. As of March 31, 2014, Legg Mason also
concluded it was the primary beneficiary of 16 employee-
owned funds it sponsors, which were consolidated and
reported as CIVs.
Other VIEs
For other sponsored investment funds that do not meet
the investment company criteria, Legg Mason 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 three CLOs in which it has a variable interest.
Although it holds no equity interest in 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 March 31,
2014, 2013 and 2012, the balances related to this CLO
were consolidated and reported as a CIV in the Company’s
consolidated financial statements. The other CLOs were not
consolidated, as their level of expected fees is insignificant.
In determining the primary beneficiary of investment
company VIEs and other VIEs, Legg Mason must make
assumptions and estimates about, among other things,
the future performance of the underlying assets held by
the VIE, including investment returns, cash flows, and
credit and interest rate risks.
Legg Mason’s investment in CIVs as of March 31, 2014
and 2013 was $39,434 and $39,056, respectively, which
represents its maximum risk of loss, excluding uncollected
advisory fees, which were not material. 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.
See Note 17 for additional information about VIEs and VREs.
Cash and Cash Equivalents
Cash equivalents are highly liquid investments with original
maturities of 90 days or less.
Restricted Cash
Restricted cash primarily represents long-term escrow
deposits and cash collateral required for market hedge
arrangements. This cash is not available to Legg Mason
for general corporate use.
Financial Instruments
Substantially all financial instruments are reflected in the
financial statements at fair value or amounts that approximate
fair value, except Legg Mason’s long-term debt.
As discussed above in “Consolidation,” seed capital
investments in proprietary fund products are initially
consolidated and the individual securities within the
portfolio are accounted for as trading investments.
Legg Mason consolidates these products as long as it
holds a controlling financial interest in the product. Upon
deconsolidation, which typically occurs after several years,
Legg Mason accounts for its investments in proprietary
fund products as equity method investments (further
described below) if its ownership is between 20%
and 50%, or it otherwise has the ability to significantly
influence the financial and operating policies of the
investee. For partnerships and LLCs, where third-party
investors may have less ability to influence operations,
the equity method of accounting is considered if Legg
Mason’s ownership is greater than 3%. Changes in the
fair value of proprietary fund products classified as trading
or equity method investments are recognized in Other
Non-Operating Income (Expense) on the Consolidated
Statements of Income (Loss).
Legg Mason generally redeems its investment in
proprietary fund products when the related product
establishes a sufficient track record, when third-party
investments in the related product are sufficient to sustain
the strategy, or a decision is made to no longer pursue
the strategy. The length of time Legg Mason holds a
majority interest in a product varies based on a number of
factors, such as market demand, market conditions and
investment performance.
See Notes 3 and 17 for additional information regarding
Legg Mason’s seed capital investments and the
determination of whether investments in proprietary fund
products represent VIEs, respectively.
For equity investments where Legg Mason does not
control the investee, and where it is not the primary
beneficiary of a VIE, but can exert significant influence
over the financial and operating policies of the investee,
Legg Mason follows the equity method of accounting.
The evaluation of whether Legg Mason can exert control
or significant influence over the financial and operational
policies of an investee requires significant judgment
65
Legg Mason based on the facts and circumstances surrounding
each individual investment. Factors considered in these
evaluations may include investor voting or other rights, any
influence Legg Mason may have on the governing board
of the investee, the legal rights of other investors in the
entity pursuant to the fund’s operating documents and the
relationship between Legg Mason and other investors in
the entity. Substantially all of Legg Mason’s equity method
investees are investment companies which record their
underlying investments at fair value. Therefore, under the
equity method of accounting, Legg Mason’s share of the
investee’s underlying net income or loss predominantly
represents fair value adjustments in the investments held
by the equity method investee. Legg Mason’s share of
the investee’s net income or loss is based on the most
current information available and is recorded as a net
gain (loss) on investments within Non-Operating Income
(Expense). A significant portion of earnings (losses)
attributable to Legg Mason’s equity method investments
has offsetting compensation expense adjustments under
revenue sharing agreements and deferred compensation
arrangements, therefore, fluctuations in the market value
of these investments will not have a material impact on
Net Income (Loss) Attributable to Legg Mason, Inc.
Legg Mason also holds debt and marketable equity
investments which are classified as available-for-sale,
held-to-maturity or trading. Debt and marketable equity
securities classified as available-for-sale are reported at
fair value and resulting unrealized gains and losses are
reflected in stockholders’ equity, noncontrolling interests,
and comprehensive income (loss), net of applicable income
taxes. Debt securities, for which there is positive intent and
ability to hold to maturity, are classified as held-to-maturity
and are recorded at amortized cost. Amortization of
discount or premium is recorded under the interest method
and is included in interest income. Certain investment
securities, including those held by CIVs, are classified
as trading securities. These investments are recorded at
fair value and unrealized gains and losses are included in
current period earnings. Realized gains and losses for all
investments are included in current period earnings.
Equity and fixed income securities classified as trading or
available-for-sale are valued using closing market prices
for listed instruments or broker price quotations, when
available. Fixed income securities may also be valued
using valuation models and estimates based on spreads to
actively traded benchmark debt instruments with readily
available market prices.
Legg Mason evaluates its non-trading investment securities
for “other-than-temporary” impairment. Impairment may
exist when the fair value of an investment security has
been below the adjusted cost for an extended period
of time. If an “other-than-temporary” impairment is
determined to exist, the amount of impairment that relates
to credit losses is recognized as a charge to income. As of
March 31, 2014, 2013 and 2012, the amount of temporary
unrealized losses for investment securities not recognized
in income was not material.
For investments in illiquid or privately-held securities for
which market prices or quotations may not be readily
available, including certain investments held by CIVs,
management estimates the value of the securities using
a variety of methods and resources, including the most
current available financial information for the investment
and the industry.
In addition to the financial instruments described above
and the derivative instruments and CLO loans, bonds and
debt, described below, other financial instruments that
are carried at fair value or amounts that approximate fair
value include Cash and cash equivalents and Short-term
borrowings. The fair values of Long-term debt at March
31, 2014 and 2013, aggregated $1,135,103 and $1,206,166,
respectively. These fair values were estimated using
publicly quoted market prices or discounted cash flow
analyses, as appropriate, and were classified as Level 2 in
the fair value hierarchy, as described below.
Derivative Instruments
The fair values of derivative instruments are recorded as
assets or liabilities on the Consolidated Balance Sheets.
Legg Mason has used foreign exchange forwards and
interest rate swaps to hedge the risk of movement in
exchange rates or interest rates on financial assets and
liabilities on a limited basis. Also, Legg Mason has used
futures contracts on index funds to hedge the market risk
of certain seed capital investments. In addition, certain
CIVs use derivative instruments. However, there is no
risk to Legg Mason in relation to the derivative assets and
liabilities of the CIVs in excess of its investment in the
funds, if any.
Legg Mason has not designated any financial instruments
for hedge accounting, as defined in the accounting
literature, during the periods presented. The gains or
losses on derivative instruments not designated for hedge
accounting are included as Other income (expense) or
Other Non-Operating Income (Expense) in the Consolidated
Statements of Income (Loss), with the exception of gains
and losses on derivative instruments of CIVs, which
are recorded as Other non-operating income (loss) of
consolidated investment vehicles, net, in the Consolidated
Statements of Income (Loss).
66
Legg Mason Fair Value Measurements
Accounting guidance for fair value measurements defines
fair value and establishes a framework for measuring fair
value. Fair value is defined as the exchange price that
would be received for an asset or paid to transfer a liability
in the principal or most advantageous market for the
asset or liability in an orderly transaction between market
participants on the measurement date. Under accounting
guidance, a fair value measurement should reflect all of
the assumptions that market participants would use in
pricing the asset or liability, including assumptions about
the risk inherent in a particular valuation technique, the
effect of a restriction on the sale or use of an asset, and
the risk of non-performance.
The objective of fair value accounting measurements is
to reflect, at the date of the financial statements, how
much an asset would be sold for in an orderly transaction
(as opposed to a distressed or forced transaction) under
current market conditions. Specifically, it requires the
use of judgment to ascertain if a formerly active market
has become inactive and in determining fair values when
markets have become inactive. This accounting guidance
also relates to other-than-temporary impairments and
is intended to bring greater consistency to the timing
of impairment recognition. It is also intended to provide
greater clarity to investors about the credit and noncredit
components of impaired debt securities that are not
expected to be sold. The guidance also requires timely
disclosures regarding expected cash flows, credit losses,
and an aging of securities with unrealized losses.
Fair value accounting guidance also establishes a hierarchy
that prioritizes the inputs for valuation techniques used
to measure fair value. The fair value hierarchy gives the
highest priority to quoted prices in active markets for
identical assets or liabilities and the lowest priority to
unobservable inputs.
Legg Mason’s financial instruments are measured and
reported at fair value and are classified and disclosed in
one of the following categories:
Level 1—Financial instruments for which prices are
quoted in active markets, which, for Legg Mason,
include investments in publicly traded mutual funds
with quoted market prices and equities listed in
active markets.
Level 2—Financial instruments for which: prices
are quoted for similar assets and liabilities in active
markets; prices are quoted for identical or similar
assets in inactive markets; or prices are based on
observable inputs, other than quoted prices, such
as models or other valuation methodologies. For
Legg Mason, this category may include fixed income
securities and certain proprietary fund products.
This category also includes CLO loans and derivative
liabilities of a CIV.
Level 3—Financial instruments for which values
are based on unobservable inputs, including those
for which there is little or no market activity. This
category includes investments in partnerships, limited
liability companies, private equity funds and CLO
debt of a CIV. This category may also include certain
proprietary fund products with redemption restrictions.
The valuation of an asset or liability may involve inputs from
more than one level of the hierarchy. The level in the fair
value hierarchy in which a fair value measurement falls in its
entirety is determined based on the lowest level input that
is significant to the fair value measurement in its entirety.
Certain proprietary fund products and investments held by
CIVs are valued at net asset value (“NAV”) determined by
the applicable fund administrator. These funds are typically
invested in exchange traded investments with observable
market prices. Their valuations may be classified as
Level 1, Level 2 or Level 3 based on whether the fund
is exchange traded, the frequency of the related NAV
determinations and the impact of redemption restrictions.
For investments in illiquid and privately-held securities
(private equity and investment partnerships) for which
market prices or quotations may not be readily available,
including certain investments held by CIVs, management
must estimate the value of the securities using a variety
of methods and resources, including the most current
available financial information for the investment and the
industry to which it applies in order to determine fair value.
These valuation processes for illiquid and privately-held
securities inherently require management’s judgment and
are therefore classified in Level 3.
The fair values of CLO loans and bonds are determined
based on prices from well-recognized third-party pricing
services that utilize available market data and are therefore
classified as Level 2. Legg Mason has established controls
designed to assess the reasonableness of the prices
provided. The fair value of CLO debt is valued using
a discounted cash flow methodology. Inputs used to
determine the expected cash flows include assumptions
about forecasted default and recovery rates that a market
participant would use in determining the fair value of the
CLO’s underlying collateral assets. Given the significance
of the unobservable inputs to the fair value measurement,
the CLO debt valuation is classified as Level 3.
67
Legg Mason Exchange traded options are valued using the last sale
price or, in the absence of a sale, the last offering price.
Options traded over the counter are valued using dealer
supplied valuations. Options are classified as Level 1.
Futures contracts are valued at the last settlement price at
the end of each day on the exchange upon which they are
traded and are classified as Level 1.
As a practical expedient, Legg Mason relies on the NAV
of certain investments, classified as Level 2 or Level 3,
as their fair value. The NAVs that have been provided by
investees are derived from the fair values of the underlying
investments as of the reporting date.
Any transfers between categories are measured at the
beginning of the period.
See Note 3 for additional information regarding fair
value measurements.
Fair Value Option
Legg Mason has elected the fair value option for certain
eligible assets and liabilities, including corporate loans
and debt, of a CLO it is consolidating (see Note 17).
Management believes that the use of the fair value option
mitigates the impact of certain timing differences and
better matches the changes in fair value of assets and
liabilities related to the CLO. Unrealized gains and losses
on assets and liabilities for which the fair value option has
been elected are reported in earnings. The decision to
elect the fair value option is determined on an instrument
by instrument basis, must be applied to an entire
instrument, and is irrevocable once elected. Assets and
liabilities which are measured at fair value pursuant to the
fair value option are included in the assets and liabilities
of consolidated investment vehicles in the Consolidated
Balance Sheets. At this time, the Company has not
elected to apply the fair value option to any of its other
financial instruments.
Appropriated Retained Earnings
Upon the election of the fair value option for eligible assets
and liabilities of the CLO described above, Legg Mason
recorded a cumulative effect adjustment to Appropriated
retained earnings for consolidated investment vehicle on
the Consolidated Balance Sheets equal to the difference
between the fair values of the CLO’s assets and liabilities.
This difference is recorded as “Appropriated retained
earnings for consolidated investment vehicle” because the
investors in the CLO, not Legg Mason shareholders, will
ultimately realize any benefits or losses associated with
the CLO. Changes in the fair values of the CLO assets and
liabilities are recorded as Net income (loss) attributable to
noncontrolling interests in the Consolidated Statements
of Income (Loss) and Appropriated retained earnings
for consolidated investment vehicle in the Consolidated
Balance Sheets. At March 31, 2014, the CLO is in the
final stage of liquidation, and the fair value of its assets
and liabilities are substantially equal, and there is no
Appropriated retained earnings.
Fixed Assets
Fixed assets primarily consist of equipment, software
and leasehold improvements. Equipment consists
primarily of communications and technology hardware and
furniture and fixtures. Software includes both purchased
software and internally developed software. Fixed assets
are reported at cost, net of accumulated depreciation
and amortization. Depreciation and amortization are
determined by use of the straight-line method. Equipment
is depreciated over the estimated useful lives of the
assets, generally ranging from three to eight years.
Software is amortized over the estimated useful lives of
the assets, which are generally three years. Leasehold
improvements are amortized or depreciated over the initial
term of the lease unless options to extend are likely to be
exercised. Maintenance and repair costs are expensed
as incurred. Internally developed software is reviewed
periodically to determine if there is a change in the useful
life, or if an impairment in value may exist. If impairment is
deemed to exist, the asset is written down to its fair value
or is written off if the asset is determined to no longer
have any value.
Intangible Assets and Goodwill
Legg Mason’s identifiable intangible assets consist
principally of asset management contracts, contracts
to manage proprietary mutual funds or funds-of-hedge
funds, and trade names resulting from acquisitions.
Intangible assets are amortized over their estimated
useful lives, using the straight-line method, unless the
asset is determined to have an indefinite useful life. Asset
management contracts are amortizable intangible assets
that are capitalized at acquisition and amortized over the
expected life of the contract. The value of contracts to
manage assets in proprietary mutual funds or funds-of-
hedge funds and the value of trade names are classified
as indefinite-life intangible assets. The assignment of
indefinite lives to proprietary fund contracts is based upon
the assumption that there is no foreseeable limit on the
contract period to manage proprietary funds due to the
likelihood of continued renewal at little or no cost. The
assignment of indefinite lives to trade names is based on
the assumption that they are expected to generate cash
flows indefinitely.
Goodwill represents the residual amount of acquisition
cost in excess of identified tangible and intangible assets
and assumed liabilities. Indefinite-life intangible assets
68
Legg Mason and goodwill are not amortized for financial statement
purposes. Given the relative significance of intangible
assets and goodwill to the Company’s consolidated
financial statements, on a quarterly basis Legg Mason
considers if triggering events have occurred that may
indicate that the fair values have declined below their
respective carrying amounts. Triggering events may
include significant adverse changes in the Company’s
business, legal or regulatory environment, loss of key
personnel, significant business dispositions, or other
events, including changes in economic arrangements
with our affiliates that will impact future operating results.
If a triggering event has occurred, the Company will
perform quantitative tests, which include critical reviews
of all significant factors and assumptions, to determine
if any intangible assets or goodwill are impaired. Legg
Mason considers factors such as projected cash flows
and revenue multiples, to determine whether the
value of the assets is impaired and the indefinite-life
assumptions are appropriate. If an asset is impaired, the
difference between the value of the asset reflected on
the consolidated financial statements and its current fair
value is recognized as an expense in the period in which
the impairment is determined. If a triggering event has
not occurred, the Company performs quantitative tests
annually at December 31, for indefinite-life intangible
assets and goodwill, unless the Company can qualitatively
conclude that it is more likely than not that the respective
fair values exceed the related carrying values. The fair
values of intangible assets subject to amortization are
considered for impairment at each reporting period
using an undiscounted cash flow analysis. For intangible
assets with indefinite lives, fair value is determined from
a market participant’s perspective based on projected
discounted cash flows, which take into consideration
estimates of future fees, profit margins, growth rates,
taxes, and discount rates. Proprietary fund contracts that
are managed and operated as a single unit and meet
other criteria may be aggregated for impairment testing.
Goodwill is evaluated at the reporting unit level, and is
considered for impairment when the carrying value of
the reporting unit exceeds the implied fair value of the
reporting unit. In estimating the implied fair value of the
reporting unit, Legg Mason uses valuation techniques
principally based on discounted projected cash flows
and EBITDA multiples, similar to techniques employed
in analyzing the purchase price of an acquisition.
Goodwill is deemed to be recoverable at the reporting
unit level, which is also the operating segment level that
Legg Mason defines as the Global Asset Management
segment. This results from the fact that the chief
operating decision maker, Legg Mason’s Chief Executive
Officer, regularly receives discrete financial information
at the consolidated Global Asset Management business
level and does not regularly receive discrete financial
information, such as operating results, at any lower level,
such as the asset management affiliate level. Allocations
of goodwill for management restructures, acquisitions
and dispositions are based on relative fair values of the
respective businesses restructured, added to or sold from
the divisions.
See Note 5 for additional information regarding intangible
assets and goodwill and Note 16 for additional business
segment information.
Translation of Foreign Currencies
Assets and liabilities of foreign subsidiaries that are
denominated in non-U.S. dollar functional currencies
are translated at exchange rates as of the Consolidated
Balance Sheet dates. Revenues and expenses are
translated at average exchange rates during the period.
The gains or losses resulting from translating foreign
currency financial statements into U.S. dollars are included
in stockholders’ equity and comprehensive income
(loss). Gains or losses resulting from foreign currency
transactions are included in Net Income (Loss).
Investment Advisory Fees
Legg Mason earns investment advisory fees on assets
in separately managed accounts, investment funds, and
other products managed for Legg Mason’s clients. These
fees are primarily based on predetermined percentages
of the market value of the assets under management
(“AUM”), are recognized over the period in which services
are performed and may be billed in advance of the period
earned based on AUM at the beginning of the billing
period in accordance with the related advisory contracts.
Revenue associated with advance billings is deferred and
included in Other (current) liabilities in the Consolidated
Balance Sheets and is recognized over the period earned.
Performance fees may be earned on certain investment
advisory contracts for exceeding performance benchmarks
on a relative or absolute basis, depending on the product,
and are recognized at the end of the performance
measurement period. Accordingly, neither advanced
billings nor performance fees are subject to reversal. The
largest portion of performance fees are earned based
on 12-month performance periods that end in differing
quarters during the year, with a portion also based on
quarterly performance periods.
Legg Mason has responsibility for the valuation of AUM,
substantially all of which is based on observable market
data from independent pricing services, fund accounting
agents, custodians or brokers.
69
Legg Mason Distribution and Service Fees Revenue and Expense
Distribution and service fees represent fees earned from
funds to reimburse the distributor for the costs of marketing
and selling fund shares and servicing proprietary funds and
are generally determined as a percentage of client assets.
Reported amounts also include fees earned from providing
client or shareholder servicing, including record keeping or
administrative services to proprietary funds. Distribution
fees earned on company-sponsored investment funds
are reported as revenue. When Legg Mason enters into
arrangements with broker-dealers or other third parties
to sell or market proprietary fund shares, distribution
and servicing expense is accrued for the amounts owed
to third parties, including finders’ fees and referral fees
paid to unaffiliated broker-dealers or introducing parties.
Distribution and servicing expense also includes payments
to third parties for certain shareholder administrative services
and sub-advisory fees paid to unaffiliated asset managers.
Deferred Sales Commissions
Commissions paid to financial intermediaries in connection
with sales of certain classes of company-sponsored mutual
funds are capitalized as deferred sales commissions. The
asset is amortized over periods not exceeding six years,
which represent the periods during which commissions
are generally recovered from distribution and service fee
revenues and from contingent deferred sales charges
(“CDSC”) received from shareholders of those funds upon
redemption of their shares. CDSC receipts are recorded
as distribution and service fee revenue when received and
a reduction of the unamortized balance of deferred sales
commissions, with a corresponding expense.
Management periodically tests the deferred sales
commission asset for impairment by reviewing the changes
in value of the related shares, the relevant market conditions
and other events and circumstances that may indicate an
impairment in value has occurred. If these factors indicate
an impairment in value, management compares the
carrying value to the estimated undiscounted cash flows
expected to be generated by the asset over its remaining
life. If management determines that the deferred sales
commission asset is not fully recoverable, the asset will be
deemed impaired and a loss will be recorded in the amount
by which the recorded amount of the asset exceeds its
estimated fair value. For the years ended March 31, 2014,
2013 and 2012, no impairment charges were recorded.
Deferred sales commissions, included in Other non-current
assets in the Consolidated Balance Sheets, were $8,031
and $8,259 at March 31, 2014 and 2013, respectively.
Income Taxes
Deferred income taxes are provided for the effects
of temporary differences between the tax basis of an
asset or liability and its reported amount in the financial
statements. Deferred income tax assets are subject to a
valuation allowance if, in management’s opinion, it is more
likely than not that these benefits will not be realized. Legg
Mason’s deferred income taxes principally relate to net
operating loss and other carryforward benefits, business
combinations, amortization of intangible assets and
accrued compensation.
Under applicable accounting guidance, a tax benefit should
only be recognized if it is more likely than not that the
position will be sustained based on its technical merits.
A tax position that meets this threshold is measured
as the largest amount of benefit that has a greater than
50% likelihood of being realized upon settlement by the
appropriate taxing authority having full knowledge of all
relevant information.
The Company’s accounting policy is to classify interest
related to tax matters as interest expense and related
penalties, if any, as other operating expense.
See Note 7 for additional information regarding income taxes.
Loss Contingencies
Legg Mason accrues estimates for loss contingencies
related to legal actions, investigations, and proceedings,
exclusive of legal fees, when it is probable that a liability
has been incurred and the amount of loss can be
reasonably estimated. Related insurance recoveries are
recorded separately when the underwriter has confirmed
coverage of a specific claim amount. See Note 8 for
additional information.
Stock-Based Compensation
Legg Mason’s stock-based compensation includes stock
options, an employee stock purchase plan, market-based
performance shares payable in common stock, restricted
stock awards and units, management equity plans for certain
affiliates and deferred compensation payable in stock. Under
its stock compensation plans, Legg Mason issues equity
awards to directors, officers, and other key employees.
In accordance with the applicable accounting guidance,
compensation expense includes costs for all non-vested
share-based awards classified as equity at their grant date
fair value amortized over the respective vesting periods on
the straight-line method. Legg Mason determines the fair
value of stock options and affiliate management equity plan
grants using the Black-Scholes option-pricing model, with the
exception of market-based performance grants, which are
70
Legg Mason valued with a Monte Carlo option-pricing model. See “Other
Developments” below and Note 11 for additional information
regarding stock-based compensation.
Earnings Per Share
Basic earnings per share attributable to Legg Mason, Inc.
common shareholders (“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
certain unvested share-based payment awards that are
considered participating securities because they contain
nonforfeitable rights to dividends. Diluted EPS is similar to
basic EPS, but adjusts for the effect of potential common
shares unless they are antidilutive. For periods with a net
loss, potential common shares are considered antidilutive.
See Note 12 for additional discussion of EPS.
Restructuring Costs
In May 2010, Legg Mason’s management committed to
a plan to streamline its business model as further described
in Note 15. 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 (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.
As further discussed in Note 2, in March 2014, Legg Mason
entered into a definitive agreement to acquire QS Investors
Holdings, LLC (“QS Investors”). Legg Mason plans to
integrate its two existing affiliates, Batterymarch Financial
Management, Inc. (“Batterymarch”) and Legg Mason
Global Asset Allocation, LLC (“LMGAA”) into QS Investors
over time to leverage the best aspects of each subsidiary.
The costs anticipated with this integration primarily relate
to employee termination benefits, including severance and
retention incentives, which are recorded as Compensation
and benefits in the Consolidated Statements of Income
(Loss). See Note 2 for additional information.
Other Developments
In conjunction with the December 2012 modification
of employment and other arrangements with certain
employees of its subsidiary, The Permal Group, Ltd
(“Permal”), Legg Mason completed implementation of a
management equity plan during the quarter ended June
30, 2013. On March 31, 2014, a similar management
equity plan was implemented by Legg Mason for
certain employees of ClearBridge Investments, LLC
(“ClearBridge”). The plans better align the interests of
each affiliate’s management with those of Legg Mason
and its shareholders, and provide for, among other things,
higher margins at specified higher revenue levels. The
management equity plans entitle certain key employees
of each affiliate to participate in 15% of the future growth,
if any, of the respective affiliates’ enterprise value (subject
to appropriate discounts) subsequent to the date of grant.
Current and future grants under the plans vest 20%
annually for five years, over which the related grant-date
fair values will be recognized as Compensation expense
in the Consolidated Statements of Income. Once vested,
plan units can be put to Legg Mason for settlement at
fair value, beginning one year after the holder terminates
their employment. Legg Mason can also call plan units,
generally post employment, for settlement at fair value.
Changes in control of Legg Mason or either affiliate do not
impact vesting, settlement or other provisions of the units.
However, upon sale of substantially all of the affiliate’s
assets, the vesting of the respective units would accelerate
and participants would receive a fair value payment in
respect of their interests under the plan. Future grants of
additional plan units will dilute the participation of existing
outstanding units in 15% of the future growth of the
respective affiliates’ enterprise value, if any, subsequent
to the related future grant date, for which additional
compensation expense would be incurred. Further, future
grants under either plan will not entitle the plan participants,
collectively, to more than an aggregate 15% of the future
growth of the respective affiliate’s enterprise value. Upon
vesting, the grant-date fair value of vested plan units
will be reflected in the Consolidated Balance Sheets as
redeemable noncontrolling interests through an adjustment
to additional paid-in capital. Thereafter, redeemable
noncontrolling interests will continue to be adjusted to the
ultimate maximum estimated redemption value over the
expected term, through retained earnings adjustments. See
Note 11 for additional information.
Noncontrolling Interests
For CIVs with third-party investors, the related
noncontrolling interests are classified as redeemable
noncontrolling interests if investors in these funds
may request withdrawals at any time. Also included
in redeemable noncontrolling interests are vested
affiliate management equity plan units. There are no
nonredeemable noncontrolling interests as of March
31, 2014 or 2013. As noted above, Net income (loss)
attributable to noncontrolling interests in the Consolidated
71
Legg Mason Statements of Income (Loss) 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 years ended March 31, 2014, 2013 and 2012, included the
following amounts:
Net income attributable to redeemable noncontrolling interests
Net Income (loss) reclassified to Appropriated retained earnings
for consolidated investment vehicle
Total
2014
$ 1,881
(4,829)
$(2,948)
2013
$ 971
(7,392)
$(6,421)
2012
$ 8,915
1,299
$10,214
Redeemable noncontrolling interests as of and for the years ended March 31, 2014, 2013 and 2012, included the following amounts:
Balance, beginning of period
Net income attributable to redeemable noncontrolling interests
Net (redemptions/distributions paid to)/subscriptions received
from noncontrolling interest holders
Management equity plan interests
Balance, end of period
Recent Accounting Developments
In June 2013, the Financial Accounting Standards Board
(“FASB”) updated the guidance for investment company
entities. The update clarifies the characteristics of an
investment company, provides comprehensive guidance
for assessing whether an entity is an investment
company, requires an investment company to measure
noncontrolling ownership interests in other investment
companies at fair value rather than using the equity
method, and requires additional disclosures. This update
will be effective for Legg Mason in fiscal 2015. Legg
Mason is currently evaluating its adoption and it is not
expected to have a material impact on Legg Mason’s
consolidated financial statements.
In December 2013, the FASB ratified an Emerging Issues
Task Force (“EITF”) consensus that will update the
guidance on measuring the financial assets and financial
liabilities of consolidated collateralized financing entities.
The update will require that an entity electing to apply the
guidance should measure both the financial assets and
financial liabilities using the fair value of the consolidated
collateralized financing entity’s financial assets or financial
liabilities, whichever is more observable. Subject to formal
issuance by the FASB, this update will also require certain
disclosures by entities that apply its provisions and will be
effective for Legg Mason in fiscal 2016, unless adopted
earlier. Legg Mason is evaluating its adoption.
2014
$21,009
1,881
20,438
1,816
$45,144
2013
$24,031
971
(3,993)
—
2012
$ 36,712
8,915
(21,596)
—
$21,009
$ 24,031
2. ACQUISITIONS
Fauchier Partners Management, Limited
On March 13, 2013, Permal, a wholly-owned subsidiary
of Legg Mason, completed the acquisition of all of
the outstanding share capital of Fauchier Partners
Management, Limited (“Fauchier”), a European based
manager of funds-of-hedge funds, from BNP Paribas
Investment Partners, S.A. in accordance with a Sale and
Purchase Agreement (“SPA”) entered into in December
2012. This transaction significantly expands Permal’s
institutional business, creating a global institutional
capability across geographies and client profiles. At
the time of acquisition, Fauchier managed assets of
approximately $5,400,000.
The initial purchase price was a cash payment of $63,433,
using the exchange rate between the British pound
and U.S. dollar at the acquisition date, and was funded
from existing cash resources. In addition, contingent
consideration of up to approximately $25,000 and
approximately $33,000 (using the exchange rate between
the British pound and the U.S. dollar as of March 31,
2014) may be due on or about the second and fourth
anniversaries of closing, respectively, dependent on
achieving certain levels of revenue, net of distribution
costs, and subject to a potential catch-up adjustment in
the fourth anniversary payment for any second anniversary
72
Legg Mason payment shortfall. The contingent consideration liability
established at closing had an acquisition date fair value
of $21,566, which represented the present value of the
contingent consideration expected to be paid. As of March
31, 2014, the fair value of the contingent consideration
liability was $29,553, an increase of $7,653 from March
31, 2013, with $5,000 attributable to revised estimates of
amounts that will be payable and $2,653 attributable to
changes in the exchange rate and interest amortization.
The contingent consideration liability is included in Other
liabilities in the Consolidated Balance Sheet. The increase
in the contingent consideration liability due to revised
estimates of amounts that will be payable was recorded in
Other expenses in the Consolidated Statements of Income
(Loss) for the year ended March 31, 2014. Legg Mason
has executed currency forwards to economically hedge
the risk of movements in the exchange rate between the
U.S. dollar and the British pound in which the estimated
contingent liability payment amounts are denominated.
See Note 14 for additional information regarding
derivatives and hedging.
A summary of the acquisition-date fair values of the assets
acquired and liabilities assumed are as follows:
Cash
Receivables
Amortizable asset management contracts
Indefinite-life fund management contracts
Goodwill
Other current liabilities, net
Contingent consideration
Deferred tax liability
Total net assets acquired
$ 8,156
12,174
2,865
65,126
28,983
(16,667)
(21,566)
(15,638)
$ 63,433
The fair value of the amortizable asset management
contracts is being amortized over a period of six years.
None of the acquired intangible assets or goodwill are
deductible for U.K. tax purposes.
Management estimated the fair values of the indefinite-life fund management contracts based upon discounted cash flow
analyses, and the contingent consideration expected to be paid based upon probability-weighted revenue projections,
using unobservable market data inputs, which are Level 3 measurements. As is typical with the acquisition of a portion
of a business from a larger financial services firm with other related operations, Legg Mason expected some initial
contraction in the acquired business. The significant assumptions used in these analyses at acquisition included projected
annual cash flows, revenues and discount rates, are summarized as follows:
Indefinite-life fund management contracts
(35)% to 11% (weighted-average - 6%)
Projected Cash Flow Growth Rates
Contingent consideration
Projected Revenue Growth Rates
(16)% to 3% (weighted-average - (5)%)
Discount Rate
16.0%
Discount Rate
2.0%
The revised contingent consideration estimate at
March 31, 2014, considers the higher level of Fauchier
performance fees to date and includes various scenarios
with net revenue growth rates ranging from 0% to 8%
(weighted-average 2%) and a discount rate of 2.7%.
The Company has not presented pro forma combined
results of operations for this acquisition because the
results of operations as reported in the accompanying
Consolidated Statements of Income (Loss) for the years
ended March 31, 2013 or 2012, would not have been
materially different. The financial results of Fauchier
included in Legg Mason’s consolidated financial results
for the year ended March 31, 2014, include revenues of
$72,088. Fauchier operations have been integrated such
that the related expenses are not readily identifiable.
QS Investors, LLC
In March 2014, Legg Mason entered into a definitive
agreement to acquire QS Investors, a customized solutions
and global quantitative equities provider with approximately
$5,000,000 in AUM and nearly $100,000,000 in assets
under advisement as of March 31, 2014.
Legg Mason plans to integrate over time two existing
affiliates, Batterymarch and LMGAA, into QS Investors
to leverage the best capabilities of each entity. Legg
Mason will pay an initial purchase price of $11,000. In
addition, contingent consideration of up to $10,000 and
$20,000 may be due on or about the second and fourth
anniversaries of closing, respectively, dependent on the
achievement of certain net revenue targets, and subject to
a potential catch-up adjustment in the fourth anniversary
73
Legg Mason Legg Mason’s available-for-sale investments consist of
mortgage backed securities, U.S. government and agency
securities and equity securities. Gross unrealized gains
and (losses) for investments classified as available-for-sale
were $203 and $(451), respectively, as of March 31, 2014,
and $230 and $(188), respectively, as of March 31, 2013.
Legg Mason uses the specific identification method to
determine the cost of a security sold and the amount
reclassified from accumulated other comprehensive
income into earnings. The proceeds and gross realized
gains and losses from sales and maturities of available-for-
sale investments are as follows:
Available-for-sale:
Proceeds
Gross realized gains
Years Ended March 31,
2014
2013
2012
$4,306
—
$5,272
22
$6,197
6
Gross realized losses
(29)
(43)
(25)
Legg Mason had no investments classified as held-to-
maturity as of March 31, 2014 and 2013.
payment for any second anniversary payment shortfall.
The acquisition is expected to close in the first quarter of
fiscal 2015.
In connection with the integration, Legg Mason
expects to incur restructuring and transition costs of
approximately $35,000, primarily comprised of charges
for employee related costs. Charges for restructuring
and transition costs for the year ended March 31, 2014,
were approximately $2,500, which primarily represent
costs for severance and retention incentives, recorded
in Compensation and benefits in the Consolidated
Statements of Income (Loss). Legg Mason expects that
approximately $30,000 of the remaining anticipated costs
associated with the integration will be incurred in the year
ending March 31, 2015.
3. INVESTMENTS AND 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 17,
Variable Interest Entities and Consolidation of Investment
Vehicles, for information related to the assets and liabilities
of CIVs that are measured at fair value.
Legg Mason has investments in debt and equity securities
that are generally classified as trading as described in Note 1.
Investments as of March 31, 2014 and 2013, are as follows:
Investment securities:
Current investments
Available-for-sale
Other(1)
Total
2014
2013
$467,726
12,072
90
$479,888
$371,080
12,400
99
$383,579
(1) Includes investments in private equity securities that do not have readily
determinable fair values.
The net unrealized and realized gain (loss) for investment
securities classified as trading was $22,963, $18,260 and
$(6,063) for fiscal 2014, 2013 and 2012, respectively.
74
Legg Mason The fair values of financial assets and (liabilities) of the Company were determined using the following categories of inputs:
As of March 31, 2014
Quoted Prices
in Active
Markets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Total
$456,631
$ — $ — $ 456,631
—
456,631
106,226
106,226
—
—
—
106,226
562,857
109,648
ASSETS:
Cash equivalents(1):
Money market funds
Time deposits and other
Total cash equivalents
Current investments:
Trading investments relating to long-term incentive compensation plans(2)
109,648
—
Trading investments of proprietary fund products and other
trading investments(3)
260,251
75,015
190
335,456
Equity method investments relating to long-term incentive compensation
plans, proprietary fund products and other investments(4)(5)
Total current investments
Available-for-sale investment securities(6)
Investments in partnerships, LLCs and other(6)
Equity method investments in partnerships and LLCs(4)(6)
Derivative assets:
Currency and market hedges
Other investments(6)
Total
LIABILITIES:
Contingent consideration liability(7)
Derivative liabilities:
Currency and market hedges
Total
8,497
378,396
2,048
—
—
3,584
—
14,125
89,140
10,024
2,878
—
—
—
—
190
—
21,586
62,973
—
90
22,622
467,726
12,072
24,464
62,973
3,584
90
$840,659
$208,268
$ 84,839
$1,133,766
$ —
$ — $(29,553)
$ (29,553)
(2,335)
—
—
(2,335)
$ (2,335)
$ — $(29,553)
$ (31,888)
75
Legg Mason As of March 31, 2013
Quoted Prices
in Active
Markets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Total
$485,776
$ —
$ — $ 485,776
—
485,776
177,471
177,471
—
—
—
177,471
663,247
86,583
ASSETS:
Cash equivalents(1):
Money market funds
Time deposits and other
Total cash equivalents
Current investments:
Trading investments relating to long-term incentive compensation plans(2)
86,583
—
Trading investments of proprietary fund products and other
trading investments(3)
Equity method investments relating to long-term incentive compensation
plans, proprietary fund products and other investments(4)(5)
Total current investments
Available-for-sale investment securities(6)
Investments in partnerships, LLCs and other(6)
Equity method investments in partnerships and LLCs(4)(6)
Derivative assets:
Currency and market hedges
Other investments(6)
Total
LIABILITIES:
Contingent consideration liability(7)
Derivative liabilities:
Currency and market hedges
Total
158,846
69,064
246
228,156
12,600
258,029
2,034
761
1,518
1,939
—
43,741
112,805
10,354
2,620
924
—
246
12
27,762
66,338
56,341
371,080
12,400
31,143
68,780
—
—
—
99
1,939
99
$750,057
$304,174
$ 94,457
$1,148,688
$ —
$ —
$(21,900)
$ (21,900)
(781)
—
—
(781)
$ (781)
$ —
$(21,900)
$ (22,681)
(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 NAV and are classified as Level 1. Cash investments in time deposits and other 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 investments of proprietary fund products and other trading investments consist of approximately 53% and 47% in equity and debt securities,
respectively, as of March 31, 2014, and approximately 49% and 51% in equity and debt securities, respectively, as of March 31, 2013.
(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 approximate fair value) relating to long-term incentive compensation plans of $14,125 and $43,741
as of March 31, 2014 and 2013, respectively, and proprietary fund products and other investments of $8,497 and $12,600 as of March 31, 2014 and 2013,
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.
(7) See Note 2.
76
Legg Mason Proprietary fund products include seed capital investments
made by Legg Mason to fund new investment strategies
and products. Legg Mason had investments in proprietary
fund products which totaled $405,918 and $304,713,
as of March 31, 2014 and 2013, respectively, which are
substantially comprised of investments in 46 funds and 39
funds as of March 31, 2014 and 2013, respectively, that
are individually greater than $1,000 and together comprise
over 90% of the seed capital investment total in each
period. See Note 1 for additional information regarding
seed capital investments.
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 discussed below,
such that measurement uncertainty has little relevance.
The changes in financial assets and (liabilities) measured at fair value using significant unobservable inputs (Level 3) for
the years ended March 31, 2014 and 2013, are presented in the tables below:
Value as of
March 31,
2013
Purchases
Sales
Redemptions/
Settlements/
Other
Transfers
Realized and
Unrealized
Gains/
(Losses), Net
Value as of
March 31,
2014
ASSETS:
Trading investments of proprietary
fund products and other trading
investments
Investments in partnerships, LLCs
and other
Equity method investments in
partnerships and LLCs
Other investments
LIABILITIES:
$ 246
$ 1
$ —
$ (77)
$ —
$ 20
$ 190
27,762
—
(731)
(4,869)
66,338
5,154
111
—
(750)
(12)
(9,258)
—
—
—
—
(576)
21,586
1,489
62,973
(9)
90
$ 94,457
$5,155
$(1,493)
$(14,204)
$ —
$ 924
$ 84,839
Contingent consideration liability
$(21,900)
$ —
$ —
$ —
$ —
$(7,653)
$(29,553)
ASSETS:
Trading investments of proprietary
fund products and other trading
investments
Equity method investments in
proprietary fund products
Investments in partnerships, LLCs
and other
Equity method investments in
partnerships and LLCs
Other investments
LIABILITIES:
Value as of
March 31,
2012
Purchases
Sales
Redemptions/
Settlements/
Other
Transfers
Realized and
Unrealized
Gains/
(Losses), Net
Value as of
March 31,
2013
$ — $ 246
$ —
$ —
$ —
$ —
$ 246
11,778
28,763
—
—
—
(11,705)
(970)
(1,014)
166,438
2,827
(2,268)
(117,411)
124
—
—
—
—
—
—
—
(73)
—
983
27,762
16,752
66,338
(13)
111
$207,103
$ 3,073
$(3,238)
$(130,130)
$ —
$17,649
$ 94,457
Contingent consideration liability
$ — $(21,566)
$ —
$ —
$ —
$ (334)
$(21,900)
77
Legg Mason Realized and unrealized gains and losses recorded for
Level 3 investments are primarily included in Other
Non-Operating Income (Expense) on the Consolidated
Statements of Income (Loss). The change in unrealized
losses for Level 3 investments and liabilities still held at
the reporting date was $5,210 and $1,229 for the years
ended March 31, 2014 and 2013, respectively. Also,
included in realized and unrealized losses, net, for the year
ended March 31, 2014, is the change in the fair value of
the contingent consideration liability.
There were no significant transfers between Level 1 and
Level 2 during the years ended March 31, 2014 and 2013.
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 respective
reporting dates. The following table summarizes, as of March 31, the nature of these investments and any related
liquidation restrictions or other factors which may impact the ultimate value realized:
Category of Investment
Investment Strategy
Funds-of-hedge funds Global macro, fixed income, long/short
Hedge funds
equity, natural resources, systematic,
emerging market, European hedge
Fixed income—developed market, event
driven, fixed income—hedge, relative
value arbitrage, European hedge
Private equity funds
Long/short equity
Other
Total
Various
Fair Value Determined Using NAV
As of March 31, 2014
March 31,
2014
$34,771(1)
March 31,
2013
Unfunded
Commitments
Remaining
Term
$38,811(1)
n/a
n/a
19,461
22,759(2)
2,434
24,716
23,763(2)
2,408
$20,000
n/a
5,575
Up to 9 years
n/a
Various(3)
$79,425(4)
$89,698(4)
$25,575
n/a—not applicable
(1) 40% monthly redemption and 60% quarterly redemption as of March 31, 2014. 49% monthly redemption and 51% quarterly redemption as of March 31,
2013. Any remaining lockup expired in June 2013.
(2) Liquidations are expected over the remaining term.
(3) Of this balance, 10% has a remaining term of less than one year and 90% has a remaining term of 19 years.
(4) Comprised of approximately 31% and 69% of Level 2 and Level 3 assets, respectively, as of March 31, 2014 and 32% and 68% of Level 2 and Level 3 assets,
respectively, as of March 31, 2013.
There are no current plans to sell any of these investments held as of March 31, 2014.
4. FIXED ASSETS
The following table reflects the components of fixed
assets as of March 31:
Equipment
Software
Leasehold improvements
Total cost
Less: accumulated depreciation
and amortization
Fixed assets, net
2014
2013
$ 147,663
$ 152,065
249,368
227,739
209,747
222,260
606,778
602,064
(417,537)
(400,245)
$ 189,241
$ 201,819
Depreciation and amortization expense related to fixed
assets was $50,531, $73,829 and $74,221 for fiscal 2014,
2013 and 2012, respectively, and includes accelerated
depreciation and amortization of $2,542 in fiscal 2014,
primarily related to various corporate initiatives, $21,020
in fiscal 2013, related to an initiative to reduce space
requirements, and $10,256 in fiscal 2012, related to our
business streamlining initiative.
5.
INTANGIBLE ASSETS AND GOODWILL
Goodwill and indefinite-life intangible assets are not
amortized, and the values of other identifiable intangible
assets are amortized over their useful lives, unless the
assets are determined to have indefinite useful lives.
Goodwill and indefinite-life intangible assets are analyzed
to determine if the fair value of the assets exceeds the
book value. Intangible assets subject to amortization are
considered for impairment at each reporting period. If the
fair value is less than the book value, Legg Mason will
record an impairment charge.
78
Legg Mason The following table reflects the components of intangible
assets as of:
March 31,
2014
March 31,
2013
Amortizable asset
management contracts
Cost
$ 207,224
$ 208,651
Accumulated amortization
(197,255)
(186,324)
Net
9,969
22,327
Indefinite-life intangible assets
U.S. domestic mutual fund
management contracts
2,106,351
2,106,351
Permal/Fauchier funds-of-hedge
fund management contracts
698,104
Other fund management contracts
304,549
Trade names
52,800
692,133
303,951
52,800
Intangible assets, net
3,161,804
3,155,235
$3,171,773
$3,177,562
The change in indefinite-life intangible assets is
attributable to the impact of foreign currency translation.
Legg Mason completed its annual impairment testing
process of goodwill and indefinite-life intangible assets
and determined that there was no impairment in the
value of these assets as of December 31, 2013. As a
result of uncertainty regarding future market conditions
and economic results, assessing the fair value of the
reporting unit and intangible assets requires management
to exercise significant judgment. The current assessed fair
value of the indefinite-life domestic mutual funds contracts
asset related to the Citigroup Asset Management (“CAM”)
acquisition exceeds the carrying value by approximately
21%. The current assessed fair value of the indefinite-
life funds-of-hedge funds contracts asset related to
the Permal and Fauchier acquisitions exceeds the
combined carrying values by approximately 10%. Should
market performance, flows, or related assets under
management levels decrease in the near term such that
cash flow projections deviate from current projections, it
is reasonably possible that the assets could be deemed
to be impaired by a material amount. Legg Mason also
determined that no triggering events occurred as of March
31, 2014 that would require further impairment testing.
As part of Legg Mason’s annual impairment testing
process as of December 31, 2012, the Company
concluded that the carrying value of two significant
indefinite-life fund management contract intangible assets
and a trade name asset exceeded their respective fair
values, and the assets were impaired by an aggregate
amount of $734,000. The impairment charges resulted
from a number of then current trends and factors. These
factors resulted in a reduction of the projected cash flows
and Legg Mason’s overall assessment of fair value of the
assets, such that the fair value of the domestic mutual
fund management contracts asset, Permal funds-of-hedge
fund management contracts asset, and Permal trade name
declined below their carrying values, and accordingly
were impaired by $396,000, $321,000, and $17,000,
respectively. Management estimated the fair values of
the indefinite-life intangible assets based upon discounted
cash flow analyses using unobservable market data
inputs, which are Level 3 measurements. The significant
assumptions used in these cash flow analyses as of
December 31, 2012, included projected cash flows and
discount rates, summarized as follows:
Projected Cash Flow
Growth Rates
Range
Weighted-
Average
Discount
Rates
Domestic mutual funds
contracts asset
3% to 9%
6%
14.5%
Permal funds-of-hedge
funds contracts and
trade name assets
(1)% to 17%
8%
16.0%
Projected cash flow growth rates for these assets are
most dependent on product investment performance,
client AUM flows, and market conditions. Discount rates
are influenced by changes in market conditions, as well as
interest rates and other factors. Decreases in the projected
cash flow growth rates and/or increases in the discount
rates could result in lower fair value measurements and
potential additional impairments that could be material.
As of March 31, 2014, amortizable asset management
contracts are being amortized over a weighted-average
remaining life of 3.2 years.
Estimated amortization expense for each of the next five
fiscal years is as follows:
2015
2016
2017
2018
2019
Thereafter
Total
$3,381
3,145
2,479
482
482
—
$9,969
79
Legg Mason The change in the carrying value of goodwill is summarized below:
Balance as of March 31, 2012
Impact of excess tax basis amortization
Business acquisition (see Note 2)
Other, including changes in foreign exchange rates
Balance as of March 31, 2013
Impact of excess tax basis amortization
Other, including changes in foreign exchange rates
Balance as of March 31, 2014
Gross Book Value
Accumulated
Impairment
Net Book Value
$2,436,945
$(1,161,900)
$1,275,045
(21,573)
28,983
(13,290)
—
—
—
(21,573)
28,983
(13,290)
2,431,065
(1,161,900)
1,269,165
(21,675)
(6,967)
—
—
(21,675)
(6,967)
$2,402,423
$(1,161,900)
$1,240,523
Legg Mason recognizes the tax benefit of the amortization
of excess tax basis related to the CAM acquisition. In
accordance with accounting guidance for income taxes,
the tax benefit is recorded as a reduction of goodwill and
deferred tax liabilities as the benefit is realized.
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 17, Variable
Interest Entities and Consolidation of Investment Vehicles,
for information related to the debt of CIVs.
As of March 31, 2014 and 2013, Legg Mason had $750,000
and $500,000, respectively, of revolving credit facility
capacity. Pursuant to a capital plan, in June 2012, Legg
Mason entered into an unsecured credit agreement which
provided for a $500,000 revolving credit facility and a
$500,000 term loan, which was repaid in fiscal 2014,
as 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. In January 2014, Legg Mason
entered into a $250,000 incremental borrowing credit
facility, which was contemplated in, and is in addition to
the $500,000 revolving credit facility. Both revolving credit
facilities expire in June 2017. The revolving credit facilities
have interest rates of LIBOR plus 150 basis points and
annual commitment fees of 20 basis points. The interest
rates may change in the future based on changes in Legg
Mason’s credit ratings. These revolving credit facilities are
available to fund working capital needs and for general
corporate purposes. There were no borrowings outstanding
under either of these facilities as of March 31, 2014 or 2013.
The revolving credit facilities 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 March 31, 2014, Legg Mason’s net debt to
EBITDA ratio was 1.2 to 1 and EBITDA to interest expense
ratio was 12.5 to 1, and therefore, Legg Mason has
maintained compliance with the applicable covenants.
The accreted value of long-term debt consists of the following:
Current
Accreted Value
$ 645,042
393,784
—
438
1,039,264
438
$1,038,826
March 31, 2014
Unamortized
Discount
$ 4,958
6,216
—
—
11,174
—
$11,174
Maturity
Amount
$ 650,000
400,000
—
438
1,050,438
438
$1,050,000
March 31, 2013
Accreted
Value
$ 644,077
—
500,000
877
1,144,954
50,438
$1,094,516
5.5% senior notes
5.625% senior notes
Five-year amortizing term loan
Other term loans
Subtotal
Less: current portion
Total
80
Legg Mason In January 2008, Legg Mason sold $1,250,000 of 2.5%
convertible senior notes (the “Convertible Notes”) due
2015, which were refinanced in May 2012 pursuant to
the aforementioned capital plan. The refinancing was
effected through the issuance of $650,000 of 5.5% senior
notes (the “5.5% Senior Notes”) due May 2019, the
net proceeds of which, together with cash on hand and
$250,000 of additional borrowing under a then existing
revolving credit facility, were used to repurchase the entire
$1,250,000 face amount of the Convertible Notes.
5.5% Senior Notes
The $650,000 5.5% 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 5.5% Senior Notes
are subject to certain nonfinancial covenants, including
provisions relating to dispositions of certain assets, which
could require a percentage of any related proceeds to be
applied to accelerated repayments. The 5.5% 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. In February 2013, the 5.5% Senior Notes
were registered to trade publicly, consistent with the terms
of a registration rights agreement signed in connection
with the issuance. In addition, under the terms of the
5.5% Senior Notes, the interest rate paid on these notes
will increase modestly if Legg Mason’s credit ratings are
reduced below investment grade.
5.625% Senior Notes
In January 2014, Legg Mason issued $400,000 of 5.625%
senior notes due 2044 (the “5.625% Senior Notes”),
the proceeds of which, plus cash on hand, were used to
repay all $450,000 of outstanding borrowings under the
five-year term loan entered into in conjunction with the
unsecured credit agreement noted above. The 5.625%
Senior Notes were sold at a discount of $6,260 which is
being amortized to interest expense over the 30-year term.
The 5.625% 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 0.30%, together with
any related accrued and unpaid interest.
2.5% Convertible Senior Notes and
Related Hedge Transactions
Prior to the repurchase of the Convertible Notes in May
2012, as previously discussed, Legg Mason was accreting
the carrying value of the Convertible 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 $39,077 for the
years ended March 31, 2013 and 2012, respectively. The
Convertible Notes were convertible, if certain conditions
were met, at an initial conversion rate of 11.3636 shares
of Legg Mason common stock per one thousand dollar
principal amount of Convertible Notes (equivalent to a
conversion price of approximately $88 per share), or
a maximum of 14,205 shares, subject to adjustment.
Unconverted notes would mature at par in January 2015.
Upon conversion of a one thousand dollar principal amount
note, the holder would receive cash in an amount equal to
one thousand dollars or, if less, the conversion value of the
note. If the conversion value exceeded the principal amount
of the Note at conversion, Legg Mason would also deliver,
at its election, cash or common stock or a combination of
cash and common stock for the conversion value in excess
of one thousand dollars.
In connection with the sale of the Convertible Notes, in
January 2008, Legg Mason entered into convertible note
hedge transactions with respect to its common stock
(the “Purchased Call Options”) with financial institution
counterparties (“Hedge Providers”). The Purchased Call
Options were exercisable solely in connection with any
conversions of the Convertible Notes in the event that the
market value per share of Legg Mason common stock
at the time of exercise was greater than the exercise
price of the Purchased Call Options, which was equal
to the $88 conversion price of the Convertible Notes,
subject to adjustment. Simultaneously, in separate
transactions Legg Mason also sold to the Hedge Providers
warrants to purchase, in the aggregate and subject to
adjustment, 14,205 shares of common stock on a net
share-settled basis at an exercise price of $107.46 per
share of common stock. The Purchased Call Options and
warrants were not part of the terms of the Convertible
Notes and did not affect the holders’ rights under the
Convertible Notes. These hedging transactions had a
net cost of approximately $83,000, which was paid from
the proceeds of the Convertible Notes and recorded as a
reduction of additional paid-in capital.
These transactions effectively increased the conversion price
of the Convertible Notes to $107.46 per share of common
stock. Legg Mason had contractual rights, and, at execution
of the related agreements, had the ability to settle its
obligations under the conversion feature of the Convertible
Notes, the Purchased Call Options and warrants, with Legg
Mason common stock. Accordingly, these transactions were
accounted for as equity, with no subsequent adjustment for
changes in the value of these obligations.
81
Legg Mason The terms of the repurchase of the Convertible 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 Convertible Notes that replicated
and extended the contingent conversion feature of the
Convertible Notes. The cash payment of $1,256,250
to repurchase the Convertible 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 Convertible 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
Convertible Notes upon their extinguishment exceeds the
initial allocated value at issuance of $977,933, requiring
the Consolidated Statements of Cash Flows for the year
ended March 31, 2013 to include an allocation of the
$216,038 excess to operating activities.
The Warrants issued to the holders of the Convertible
Notes in connection with the repurchase of the Convertible
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 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 option 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 Convertible
Notes, the hedge transactions (Purchased Call Options
and warrants) executed in connection with the initial
issuance of the Convertible Notes were also terminated.
As of March 31, 2014, the aggregate maturities of
long-term debt, based on their contractual terms, are
as follows:
2015
2016
2017
2018
2019
Thereafter
Total
$ 438
—
—
—
—
1,050,000
$1,050,438
82
Legg Mason 7. INCOME TAXES
The components of income (loss) before income tax provision (benefit) are as follows:
Domestic
Foreign
Total
The components of income tax expense (benefit) are as follows:
Federal
Foreign
State and local
Total income tax provision (benefit)
Current
Deferred
Total income tax provision (benefit)
2014
$320,890
98,751
$419,641
2013
$(264,342)
(246,265)
$(510,607)
2012
$257,866
45,217
$303,083
2014
2013
$125,494
$ (74,185)
(1,450)
13,761
$137,805
$ 19,375
118,430
$137,805
(85,677)
9,003
$(150,859)
$ 6,496
(157,355)
$(150,859)
2012
$54,179
(7,850)
25,723
$72,052
$22,860
49,192
$72,052
A reconciliation of the difference between the effective income tax (benefit) rate and the statutory federal income tax
(benefit) rate is as follows:
Tax provision (benefit) at statutory U.S. federal income tax rate
State income taxes, net of federal income tax benefit(1)
Effect of foreign tax rates(1)
Effect of loss on Australian restructuring
Changes in U.K. tax rates on deferred tax assets and liabilities
Net (income) loss attributable to noncontrolling interests
Other, net(1)
2014
35.0%
1.8
(4.2)
—
(4.6)
0.3
4.5
2013
(35.0)%
2012
35.0%
1.5
3.8
—
(3.5)
0.5
3.2
5.4
(1.8)
(6.0)
(6.0)
(0.8)
(2.0)
Effective income tax (benefit) rate
32.8%
(29.5)%
23.8%
(1) State income taxes include changes in related valuation allowances, net of the impact on deferred tax assets of changes in state apportionment factors and
planning strategies. The effect of foreign tax rates also includes changes in related valuation allowances. Other includes changes in federal valuation allow-
ances and permanent tax adjustments. See schedule below for the change in valuation allowances by jurisdiction.
In July 2011, The U.K. Finance Act 2011 (the “Act”) was
enacted. The Act 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, which further reduced
the main U.K. corporate tax rate to 24% effective April
1, 2012 and 23% effective April 1, 2013. In July 2013,
the Finance Bill 2013 was enacted, further reducing the
main U.K. corporate tax rate to 21% effective April 1,
2014 and 20% effective April 1, 2015. The reductions
in the U.K. corporate tax rate resulted in tax benefits of
$19,164, $18,075 and $18,268, recognized in fiscal 2014,
2013 and 2012, respectively, as a result of the revaluation
of deferred tax assets and liabilities at the new rates. In
addition, during the year ended March 31, 2012, Legg
Mason recorded $18,254 of tax benefits related to a
restructuring of our Australian business.
83
Legg Mason Deferred income taxes are provided for the effects of temporary differences between the tax basis of an asset or liability
and its reported amount in the Consolidated Balance Sheets. These temporary differences result in taxable or deductible
amounts in future years. A summary of Legg Mason’s deferred tax assets and liabilities are as follows:
DEFERRED TAX ASSETS
Accrued compensation and benefits
Accrued expenses
Operating loss carryforwards
Capital loss carryforwards
Foreign tax credit carryforward
Federal benefit of uncertain tax positions
Mutual fund launch costs
Net unrealized losses from investments
Other
Deferred tax assets
Valuation allowance
2014
2013
$154,074
$ 107,411
61,575
267,940
10,015
235,661
16,914
31,774
—
303
778,256
(90,832)
73,181
449,806
41,256
115,819
21,165
24,324
4,447
5,086
842,495
(115,815)
Deferred tax assets after valuation allowance
$687,424
$ 726,680
DEFERRED TAX LIABILITIES
Basis differences, principally for intangible assets and goodwill
Depreciation and amortization
Net unrealized gains from investments
Other
Deferred tax liabilities
Net deferred tax asset
2014
2013
$ 72,596
523,595
4,743
221
601,155
$ 86,269
$ 134,873
386,959
—
1,528
523,360
$ 203,320
Certain tax benefits associated with Legg Mason’s
employee stock plans are recorded directly in
Stockholders’ Equity. No tax benefit was recorded
to equity in fiscal 2014, 2013 or 2012, due to the net
operating loss position of the Company. As of March 31,
2014, an additional $7,424 of net operating loss will be
recognized as an increase in Stockholders’ Equity when
ultimately realized.
Legg Mason has various loss carryforwards that may
provide future tax benefits. Related valuation allowances
are established in accordance with accounting guidance
for income taxes, if it is management’s opinion that it
is more likely than not that these benefits will not be
realized. Substantially all of Legg Mason’s deferred tax
assets related to U.S. federal and state and U.K. taxing
jurisdictions. As of March 31, 2014, U.S. federal deferred
tax assets aggregated $762,699, realization of which is
expected to require approximately $3,800,000 of future
U.S. earnings, approximately $673,317 of which must be
in the form of foreign source income. Based on estimates
of future taxable income, using assumptions consistent
with those used in Legg Mason’s goodwill impairment
testing, it is more likely than not that current federal tax
benefits relating to net operating losses are realizable
and no valuation allowance is necessary at this time.
With respect to those resulting from foreign tax credits,
it is more likely than not that tax benefits relating to the
utilization of $39,919 of foreign tax credits as credits will
not be realized and an additional valuation allowance of
$2,340 was provided in fiscal 2014. In addition, a valuation
allowance was established in prior years for the substantial
portion of our deferred tax assets relating to U.K. taxing
jurisdictions. While tax planning may enhance Legg
Mason’s tax positions, the realization of these current tax
benefits is not dependent on any significant tax strategies.
As of March 31, 2014, U.S. state deferred tax assets
aggregated approximately $180,183. Due to limitations on
utilization of net operating loss carryforwards and taking
into consideration certain state tax planning strategies,
a valuation allowance was established in prior years for
84
Legg Mason state net operating loss benefits generated in certain
jurisdictions. An additional valuation allowance of $8,639
was established in fiscal 2014 for the additional tax
benefits generated in these jurisdictions. Additionally,
$34,831 of fully reserved deferred tax assets relating
to U.S. state capital loss carryforwards expired unused
during fiscal 2014. Due to the uncertainty of future state
apportionment factors and future effective state tax rates,
the value of state net operating loss benefits ultimately
realized may vary.
An increase to the valuation allowance of approximately
$467 in fiscal 2014 was primarily related to the current
year change in certain U.K. deferred tax assets for which
a full valuation allowance was previously recognized. To
the extent the analysis of the realization of deferred tax
assets relies on deferred tax liabilities, Legg Mason has
considered the timing, nature and jurisdiction of reversals,
as well as, future increases relating to the tax amortization
of goodwill and indefinite-life intangible assets.
The following deferred tax assets and valuation allowances relating to carryforwards have been recorded at March 31,
2014 and 2013, respectively.
Deferred tax assets
U.S. federal net operating losses
U.S. federal capital losses
U.S. federal foreign tax credits
U.S. charitable contributions
U.S. state net operating losses(1)(2)
U.S. state capital losses
Foreign net operating losses
Foreign capital losses
Total deferred tax assets for carryforwards
Valuation allowances
U.S. federal capital losses
U.S. federal foreign tax credits
U.S. charitable contributions
U.S. state net operating losses
U.S. state capital losses
Foreign net operating losses
Foreign capital losses
Valuation allowances for carryforwards
Foreign other deferred assets
Total valuation allowances
Expires
Beginning after
Fiscal Year
2029
2015
2015
2013
2015
2015
2027
n/a
2014
2013
$ 80,515
$266,659
3,545
235,661
—
168,173
532
19,252
5,938
74
115,819
5,401
161,136
34,960
22,011
6,222
$513,616
$612,282
$ 74
$ 74
25,947
—
34,590
129
15,738
5,938
82,416
8,416
23,608
1,597
25,951
34,960
15,899
6,222
108,311
7,504
$ 90,832
$115,815
(1) Substantially all of the U.S. state net operating losses carryforward through fiscal 2029.
(2) Due to potential for change in the factors relating to apportionment of income to various states, the Company’s effective state tax rates are subject to
fluctuation which will impact the value of the Company’s deferred tax assets, including net operating losses, and could have a material impact on the future
effective tax rate of the Company.
Legg Mason had total gross unrecognized tax benefits
of approximately $77,892, $72,650 and $90,831 as of
March 31, 2014, 2013 and 2012, respectively. Of these
totals, approximately $51,518, $46,340 and $62,400,
respectively, (net of the federal benefit for state tax
liabilities) are the amounts of unrecognized benefits which,
if recognized, would favorably impact future income tax
provisions and effective tax rates. During fiscal 2014, as
a result of the net impact of expiring statutes of limitation
and the completion of tax authority examinations,
unrecognized benefits of $2,927 were realized.
85
Legg Mason A reconciliation of the beginning and ending amount of unrecognized gross tax benefits for the years ended March 31,
2014, 2013 and 2012, is as follows:
Balance, beginning of year
Additions based on tax positions related to the current year
Additions for tax positions of prior years
Reductions for tax positions of prior years
Decreases related to settlements with taxing authorities
Expiration of statutes of limitations
Balance, end of year
Although management cannot predict with any degree
of certainty the timing of ultimate resolution of matters
under review by various taxing jurisdictions, at this time
the Company does not anticipate any changes to the
gross unrecognized tax benefits balance within the next
12 months as a result of the statutes of limitations or the
completion of tax authorities’ examinations.
The Company accrues interest related to unrecognized
tax benefits in interest expense and recognizes penalties
in other operating expense. During the years ended
March 31, 2014, 2013 and 2012, the Company recognized
approximately $(580), $5,500, and $1,300, respectively,
which was substantially all interest. At March 31, 2014, 2013
and 2012, Legg Mason had approximately $7,300, $14,000,
and $10,000, respectively, accrued for interest and penalties
on tax contingencies in the Consolidated Balance Sheets.
Legg Mason’s prior year tax returns are subject to
examination by the Internal Revenue Service, the Inland
Revenue Service, Brazilian and other tax authorities in
various other countries and states. The following tax years
remain open to income tax examination for each of the
more significant jurisdictions where Legg Mason is subject
to income taxes: after fiscal 2009 for U.S. federal; after
fiscal 2012 for the United Kingdom (“U.K.”); after fiscal
2005 for Brazil; after fiscal 2009 for the state of California;
after fiscal 2008 for the state of New York; and after
fiscal 2010 for the states of Connecticut, Maryland and
Massachusetts. The Company does not anticipate making
any significant cash payments with the settlement of these
audits in excess of amounts that have been reserved.
During the year ended March 31, 2014, Legg Mason
revised its plan and completed repatriation of
approximately $301,000 of foreign accumulated earnings
in order to make the cash available in the U.S. for general
corporate purposes. Due to certain tax planning strategies,
Legg Mason anticipates that it will generate a benefit
of approximately $12,000 with respect to repatriations
2014
2013
2012
$ 72,650
$ 90,831
$77,653
5,659
12,610
(138)
(12,889)
—
11,726
8,439
(13,083)
(25,205)
(58)
9,822
10,668
(3,575)
(3,185)
(552)
$ 77,892
$ 72,650
$90,831
and has adjusted the tax reserve accordingly. No further
repatriation of accumulated prior period foreign earnings
is currently planned. However, if circumstances change,
Legg Mason will provide for and pay any applicable
additional U.S. taxes in connection with repatriation of
these funds. It is not practical at this time to determine
the income tax liability that would result from any further
repatriation of accumulated foreign earnings.
Except as noted above, Legg Mason intends to
permanently reinvest cumulative undistributed earnings of
its foreign subsidiaries in foreign operations. Accordingly,
no U.S. federal income taxes have been provided for
the undistributed earnings to the extent that they are
permanently reinvested in Legg Mason’s foreign operations.
It is not practical at this time to determine the income tax
liability that would result upon repatriation of the earnings.
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 March 31, 2014, the minimum annual aggregate
rentals under operating leases and service agreements are
as follows:
2015
2016
2017
2018
2019
Thereafter
Total
$134,280
115,694
97,595
87,080
72,879
351,275
$858,803
86
Legg Mason The minimum rental commitments shown above have
not been reduced by $172,526 for minimum sublease
rentals to be received in the future under non-cancelable
subleases, of which approximately 40% is due from one
counterparty. The lease reserve liability, included in the
table below, for space subleased as of March 31, 2014
was $36,170. If a sub-tenant defaults on a sublease, Legg
Mason may incur operating charges to adjust the existing
lease reserve liability 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
$784,221 in real estate and equipment leases and $74,582
in service and maintenance agreements.
The minimum rental commitments shown above include
$30,200 for commitments related to space that has been
vacated, but for which subleases are being pursued. The
related lease reserve liability, included in the table below,
was $19,330 as of March 31, 2014, and remains subject
to adjustment based on circumstances in the real estate
markets that may require a change in assumptions or
the actual terms of a sublease that is ultimately secured.
The lease reserve liability takes into consideration various
assumptions, including the expected amount of time it will
take to secure a sublease agreement and prevailing rental
rates in the applicable real estate markets.
The table below presents a summary of the changes in
the lease reserve liability for subleased space and vacated
space for which subleases are being pursued:
Balance as of March 31, 2011
Accrued charges for vacated and subleased space (1)
Payments, net
Adjustments and other
Balance as of March 31, 2012
Accrued charges for vacated and subleased space (1)
Payments, net
Adjustments and other
Balance as of March 31, 2013
Accrued charges for vacated and subleased space(1)
Payments, net
Adjustments and other
Balance as of March 31, 2014
$ 40,521
17,391
(12,397)
(752)
44,763
39,080
(15,341)
(1,590)
66,912
7,371
(17,117)
(1,666)
$ 55,500
(1) Included in Occupancy expense in the Consolidated Statements of Income
(Loss)
The table above includes activity related to our
business streamlining initiative. See Note 15 for
additional information.
The following table reflects rental expense under all
operating leases and servicing agreements.
2014
2013
2012
Rental expense
$130,880
$138,488
$140,285
Less: sublease income
16,289
14,750
14,310
Net rent expense
$114,591
$123,738
$125,975
Legg Mason recognizes rent expense ratably over the lease
period based upon the aggregate lease payments. The
lease period is determined as the original lease term without
renewals, unless and until the exercise of lease renewal
options is reasonably assured, and also includes any period
provided by the landlord as a “free rent” period. Aggregate
lease payments include all rental payments specified in
the contract, including contractual rent increases, and are
reduced by any lease incentives received from the landlord,
including those used for tenant improvements.
As of March 31, 2014, Legg Mason had commitments
to invest approximately $34,536 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 2021.
In connection with the acquisition of Fauchier, as further
discussed in Note 2, contingent consideration of up
to approximately $25,000 and approximately $33,000
(using the exchange rate between the British pound
and U.S. dollar as of March 31, 2014), may be due on or
about the second and fourth anniversaries of closing,
respectively, which is dependent upon achieving certain
levels of revenue, net of distribution costs, and subject to
a potential catch-up adjustment in the fourth anniversary
payment for any second anniversary payment shortfall.
The fair value of the contingent consideration liability
was $29,553 as of March 31, 2014, an increase of
$7,653 from March 31, 2013, with $5,000 attributable
to revised estimates of amounts payable and $2,653
attributable to changes in the exchange rate and interest
amortization. Legg Mason has executed currency forwards
to economically hedge the risk of movements in the
exchange rate between the U.S. dollar and the British
pound in which the estimated contingent liability payment
amounts are denominated. See Note 14 for additional
information regarding derivatives and hedging.
In connection with the acquisition of QS Investors, as
further discussed in Note 2, Legg Mason will pay an initial
purchase price of $11,000 and contingent consideration of
up to $10,000 and $20,000 may be due on or about the
second and fourth anniversaries of closing, respectively,
dependent on the achievement of certain net revenue
targets, and subject to a potential catch-up adjustment in
87
Legg Mason the fourth anniversary payment for any second anniversary
payment shortfall.
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 industry
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 March 31, 2014 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. Legg Mason
settled this matter in the fourth quarter of fiscal 2014. The
settlement was substantially covered by insurance and
did not have a material effect on Legg Mason’s financial
position, results of operations or cash flows.
Additionally, there were two matters subject to regulatory
investigations involving one of Legg Mason’s asset
management subsidiaries regarding its compliance with
applicable legal requirements with respect to investments
made for certain client accounts. These matters have
been settled with the regulators. The settlements were
substantially covered by insurance and did not have a
material effect on Legg Mason’s financial position, results
of operations or cash flows.
Legg Mason cannot estimate the reasonably possible loss
or range of loss associated with matters of litigation and
other proceedings, including those described above as
customer complaints, legal actions, inquiries, 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. 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 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 March 31, 2014, 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, insurance
88
Legg Mason reimbursement, or reductions in compensation under
revenue share arrangements.
As of March 31, 2014 and 2013, Legg Mason’s liability
for losses and contingencies was $500 and $20,300,
respectively. During fiscal 2014, 2013 and 2012, Legg
Mason had charges relating to litigation and other
proceedings of approximately $200, $5,200, and $1,100,
respectively (net of recoveries of $19,300 and $15,200 in
fiscal 2014 and 2013, respectively).
9. EMPLOYEE BENEFITS
Legg Mason, through its subsidiaries, maintains various
defined contribution plans covering substantially all
employees. Through these plans, Legg Mason can make
two types of discretionary contributions. One is a profit
sharing contribution to eligible Plan participants based on
a percentage of qualified compensation and the other is a
match of employee 401(k) contributions. Matches range
from 50% to 100% of employee 401(k) contributions,
up to a maximum of the lesser of up to 6% of employee
compensation or a specified amount up to $15 per year.
Corporate profit sharing and matching contributions,
together with contributions made under subsidiary plans,
totaled $29,355, $25,868 and $22,336 in fiscal 2014, 2013
and 2012, respectively. In addition, employees can make
voluntary contributions under certain plans.
10. CAPITAL STOCK
At March 31, 2014, the authorized numbers of common
and preferred shares were 500,000 and 4,000,
respectively. At March 31, 2014 and 2013, there were
10,333 and 11,948 shares of common stock, respectively,
reserved for issuance under Legg Mason’s equity plans.
In May 2012, as part of a 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 remaining $155,000 of a previously
authorized share repurchase program. There is no
expiration date attached to this authorization. During fiscal
2014, Legg Mason purchased and retired 9,677 shares
of its common stock for $359,996 through open market
purchases. During fiscal 2013, Legg Mason purchased and
retired 16,199 shares of its common stock for $425,475
through open market purchases, which completed the
repurchase of its common stock under the previous
authorization, and began purchases under the new
authorization. The remaining balance of the authorized
stock buyback is approximately $370,000.
In May 2008, Legg Mason issued $1,150,000 of Equity
Units, each unit consisting of a 5% interest in one
thousand dollar principal amount of senior notes due June
30, 2021, and a purchase contract committing the holder
to purchase shares of Legg Mason’s common stock by
June 30, 2011. During fiscal 2012, Legg Mason issued
1,830 shares of Legg Mason common stock upon the
exercise of the purchase contracts from the remaining
Equity Units and the senior notes from the Equity Units
were retired in a remarketing.
As discussed in Note 6, warrants issued in connection
with the repurchase of the Notes could result in the
issuance of a maximum of 14,205 shares of Legg Mason
common stock, subject to adjustment, if certain conditions
are met.
Changes in common stock for the three years ended March 31, 2014, 2013 and 2012, respectively, are as follows:
COMMON STOCK
Beginning balance
Shares issued for:
Stock option exercises and other stock-based compensation
Deferred compensation employee stock trust
Deferred compensation, net
Shares repurchased and retired
Employee tax withholding by settlement of net share transactions
Equity Units exchanged
Ending balance
Years Ended March 31,
2014
2013
2012
125,341
139,874
150,219
839
50
1,175
(9,677)
(555)
—
80
71
1,925
(16,199)
(410)
—
117,173
125,341
172
68
1,246
(13,597)
(64)
1,830
139,874
89
Legg Mason
Dividends declared per share were $0.52, $0.44 and $0.32
for fiscal 2014, 2013 and 2012, respectively. Dividends
declared but not paid at March 31, 2014, 2013 and 2012,
were $14,945, $14,185 and $11,493, respectively, and are
included in Other current liabilities.
11. STOCK-BASED COMPENSATION
Legg Mason’s stock-based compensation includes stock
options, an employee stock purchase plan, market-based
performance shares payable in common stock, restricted
stock awards and units, management equity plans 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
March 31, 2014, were 9,740. 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.
Stock Options
Compensation expense relating to stock options for the
years ended March 31, 2014, 2013 and 2012, was $13,530,
$10,979 and $14,076, respectively. The related income tax
benefit for the years ended March 31, 2014, 2013 and 2012,
was $5,244, $4,293 and $5,539, respectively.
Stock option transactions under Legg Mason’s equity incentive plans during the years ended March 31, 2014, 2013 and
2012 are summarized below:
Options outstanding at March 31, 2011
Granted
Exercised
Canceled/forfeited
Options outstanding at March 31, 2012
Granted
Exercised
Canceled/forfeited
Options outstanding at March 31, 2013
Granted
Exercised
Canceled/forfeited
Options outstanding at March 31, 2014
Number
of Shares
Weighted-Average
Exercise Price
Per Share
5,419
810
(117)
(488)
5,624
966
(25)
(1,204)
5,361
1,215
(804)
(971)
4,801
$59.82
33.99
25.32
48.80
57.78
23.72
21.80
51.87
53.13
33.64
30.52
97.49
$43.02
The total intrinsic value of options exercised during the years ended March 31, 2014, 2013 and 2012, was $6,064, $168
and $398, respectively. At March 31, 2014, the aggregate intrinsic value of options outstanding was $72,724.
The following information summarizes Legg Mason’s stock options outstanding at March 31, 2014:
Exercise Price Range
$ 12.65–$ 25.00
25.01– 35.00
35.01– 94.00
94.01– 100.00
100.01– 134.97
Option Shares
Outstanding
Weighted-Average
Exercise Price
Per Share
Weighted-Average
Remaining Life
(in years)
846
2,403
681
416
455
4,801
$ 22.95
31.89
35.16
95.13
103.21
5.8
4.9
7.1
0.3
1.2
At March 31, 2014, 2013 and 2012, options were exercisable for 2,531, 3,254 and 3,334 shares, respectively, and the
weighted-average exercise prices were $54.04, $69.07 and $73.60, respectively. Stock options exercisable at March 31,
2014, have a weighted-average remaining contractual life of 3.0 years. At March 31, 2014, the aggregate intrinsic value of
options exercisable was $31,180.
90
Legg Mason The following information summarizes Legg Mason’s stock options exercisable at March 31, 2014:
Exercise Price Range
$ 12.65–$ 25.00
25.01– 35.00
35.01– 94.00
94.01– 100.00
100.01– 134.97
Option Shares
Exercisable
Weighted-Average
Exercise Price
Per Share
241
1,412
7
416
455
2,531
$ 21.03
31.80
35.16
95.13
103.21
The following information summarizes unvested stock options under Legg Mason’s equity incentive plans for the year
ended March 31, 2014:
Shares unvested at March 31, 2013
Granted
Vested
Canceled/forfeited
Shares unvested at March 31, 2014
Number
of Shares
Weighted-Average
Grant Date
Fair Value
2,107
1,215
(984)
(68)
2,270
$11.65
33.64
29.66
29.73
$30.74
Unamortized compensation cost related to unvested
options at March 31, 2014, was $16,905 and is expected to
be recognized over a weighted-average period of 1.5 years.
Cash received from exercises of stock options under Legg
Mason’s equity incentive plans was $23,818, $660 and
$2,851 for the years ended March 31, 2014, 2013 and
2012, respectively. The tax benefit expected to be realized
for the tax deductions from these option exercises totaled
$1,815, $45 and $47 for the years ended March 31, 2014,
2013 and 2012, respectively.
The weighted-average fair value of service-based stock
option grants during the years ended March 31, 2014,
2013 and 2012, excluding those granted to our Chief
Executive Officer in May 2013 discussed below, using the
Black-Scholes option pricing model, was $12.13, $9.47 and
$13.13 per share, respectively.
The following weighted-average assumptions were used
in the model for grants in fiscal 2014, 2013 and 2012:
Expected dividend yield
Risk-free interest rate
2014
1.54%
0.80%
2013
1.44%
0.81%
2012
1.39%
1.95%
Expected volatility
45.08%
51.80%
47.16%
Expected life (in years)
4.93
5.02
5.12
In May 2013, Legg Mason awarded options to purchase
500 shares of Legg Mason, Inc. common stock at an
exercise price of $31.46, equal to the then current market
value of Legg Mason’s common stock, to its Chief
Executive Officer, which is included in the outstanding
options table. The award had a grant date fair value of
$5,525 and is subject to vesting requirements, 25% of
which vests over a two-year service period; 25% of which
vests over a two-year service period and is subject to
Legg Mason’s common stock price equaling or exceeding
$36.46 for 20 consecutive trading days; 25% of which is
subject to Legg Mason’s common stock price equaling
or exceeding $41.46 for 20 consecutive trading days; and
25% of which is subject to Legg Mason’s common stock
price equaling or exceeding $46.46 for 20 consecutive
trading days; as well as a requirement that certain shares
received upon exercise are retained for a two-year period.
In January 2014, 25% of this award vested when the
Legg Mason stock price met and exceeded $41.46 for 20
consecutive trading days.
The weighted-average fair value per share for these
awards of $11.05 was estimated as of the grant date using
a grant price of $31.46, and a Monte Carlo option pricing
model with the following assumptions:
Legg Mason uses an equally weighted combination of
both implied and historical volatility to measure expected
volatility for calculating Black-Scholes option values.
Expected dividend yield
Risk-free interest rate
Expected volatility
1.48%
0.86%
44.05%
91
Legg Mason Restricted Stock
Restricted stock and restricted stock unit transactions during the years ended March 31, 2014, 2013 and 2012 are
summarized below:
Unvested shares at March 31, 2011
Granted
Vested
Canceled/forfeited
Unvested shares at March 31, 2012
Granted
Vested
Canceled/forfeited
Unvested shares at March 31, 2013
Granted
Vested
Canceled/forfeited
Unvested shares at March 31, 2014
Number
of Shares
Weighted-Average
Grant Date Value
2,637
1,370
(1,075)
(59)
2,873
2,185
(1,177)
(143)
3,738
1,369
(1,622)
(151)
3,334
$33.01
33.48
31.49
32.68
33.83
24.04
31.22
58.30
27.99
35.66
28.66
29.04
$30.77
The restricted stock and restricted stock unit awards were
non-cash transactions. In fiscal 2014, 2013 and 2012,
Legg Mason recognized $48,263, $46,351 and $32,826,
respectively, in compensation expense and related tax
benefits of $18,575, $17,697 and $12,705, respectively,
for restricted stock and restricted stock unit awards.
Unamortized compensation cost related to unvested
restricted stock and restricted stock unit awards for 3,334
shares not yet recognized at March 31, 2014, was $63,479
and is expected to be recognized over a weighted-average
period of 1.7 years.
In connection with the change in Legg 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.
In March 2013, the vesting of 85 of these shares was
accelerated. The remaining shares vested on March 31,
2014. Compensation expense for the year ended March
31, 2013, includes approximately $6,400 of accelerated
stock-based net compensation costs associated with the
departure of Legg Mason executive officers during fiscal
2013, of which $1,400 relates to the accelerated vesting of
shares in March 2013.
On January 28, 2008, the Legg Mason Compensation
Committee approved grants to senior officers of 120
market-based performance shares. During fiscal 2013,
the remaining 100 shares from this award were forfeited
resulting in no outstanding balance as of March 31, 2013.
Other
Legg Mason has a qualified Employee Stock Purchase
Plan covering substantially all U.S. employees. Shares
of common stock are purchased in the open market on
behalf of participating employees, subject to a 4,500 total
share limit under the plan. Purchases are made through
payroll deductions and, effective January 2014, Legg
Mason provides a 15% contribution towards purchases,
which is charged to earnings. Prior to January 2014, Legg
Mason’s contribution was 10%. During the fiscal years
ended March 31, 2014, 2013 and 2012, approximately 85,
107, and 107 shares, respectively, have been purchased in
the open market on behalf of participating employees. In
fiscal 2014, 2013 and 2012, Legg Mason recognized $315,
$238 and $267, respectively, in compensation expense
related to the stock purchase plan.
In June 2013, Legg Mason implemented a management
equity plan and granted units to key employees of
Permal that entitle them to participate in 15% of the
future growth of the Permal enterprise value (subject to
appropriate discounts), if any, subsequent to the grant
date. On March 31, 2014, a similar management equity
plan was implemented by Legg Mason with a grant
to certain key employees of ClearBridge. Independent
valuations determined the aggregate cost of the awards
to be approximately $9,000 and $16,000 for Permal and
ClearBridge, respectively, which will be recognized as
Compensation expense in the Consolidated Statements
of Income (Loss) over the related vesting periods, through
92
Legg Mason December 2017 and March 2019, respectively. Both
arrangements provide that one-half of the respective
cost will be absorbed by the affiliate’s incentive pool.
Compensation expense related to the Permal management
equity plan was $2,270 for the year ended March 31, 2014.
Legg Mason also has an equity plan for non-employee
directors. Under the current equity plan, directors may elect
to receive shares of stock or restricted stock units. Prior to a
July 19, 2007 amendment to the Plan, directors could also
elect to receive stock options. Options granted under the
old plan are immediately exercisable at a price equal to the
market value of the shares on the date of grant and have a
term of not more than ten years. In fiscal 2014, 2013 and
2012, Legg Mason recognized expense of $1,950, $1,250
and $1,375, respectively, for awards under this plan. Shares,
options, and restricted stock units issuable under the equity
plan are limited to 625 shares in aggregate, of which 360
shares were issued under the plan as of March 31, 2014. As
of March 31, 2014, 2013 and 2012 non-employee directors
held 32, 112 and 184, stock options, respectively, which are
included in the outstanding options table. As of March 31,
2014, 2013 and 2012, non-employee directors held 64, 91
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 year ended March 31,
2014, there were 39 restricted stock units distributed and
non-employee directors did not exercise any stock options.
During the years ended March 31, 2013 and 2012, non-
employee directors did not exercise any stock options and
no restricted stock units were distributed. During the years
ended March 31, 2014, 2013 and 2012, non-employee
directors were granted 12, 17 and 12 restricted stock units
and 47, 35 and 31 shares of common stock, respectively.
For the year ended March 31, 2014, there were 26 stock
options canceled or forfeited from the current equity plan
for non-employee directors. For the years ended March 31,
2013 and 2012, there were no stock options canceled or
forfeited from the current equity plan for non-employee
directors. For the years ended March 31, 2014, 2013 and
2012, there were 54, 72 and 36 stock options canceled or
forfeited, respectively, related to a prior equity plan for non-
employee directors which was discontinued in July 2005.
During fiscal 2012, Legg Mason established a long-term
incentive plan (the “LTIP”) under its equity incentive plan,
which provided an additional element of compensation
to executives that is based on performance, determined
as the achievement of a pre-defined amount of Legg
Mason’s cumulative adjusted earnings per share over the
respective performance periods. Under the LTIP, current
executive officers were granted cash value performance
units in the quarters ended June 2011 and September
2012 for target amounts up to $1,850 in each period.
Awards granted under the LTIP that vest 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. The June
2011 grant performance period ended March 31, 2014,
and no cash and/or shares were due. The September 2012
grant performance period ends March 31, 2015 and no
further grants are intended.
Deferred compensation payable in shares of Legg Mason
common stock has been granted to certain employees
in an elective plan. The vesting in the plan is immediate
and the plan provides for discounts of up to 10% on
contributions and dividends. There are 327 additional
shares reserved for future issuance under the plan. In
fiscal 2014, 2013 and 2012, Legg Mason recognized $160,
$165 and $191, respectively, in compensation expense
related to this plan. During fiscal 2014, 2013 and 2012,
Legg Mason issued 51, 71 and 68 shares, respectively,
under the plan with a weighted-average fair value per
share at the grant date of $31.90, $23.07 and $27.05,
respectively. The undistributed shares issued under this
plan are held in a rabbi trust. Assets of the rabbi trust are
consolidated with those of the employer, and the value of
the employer’s stock held in the rabbi trust is classified in
stockholders’ equity and accounted for in a manner similar
to treasury stock. Therefore, the shares Legg Mason has
issued to its rabbi trust and the corresponding liability
related to the deferred compensation plan are presented
as components of stockholders’ equity as Employee stock
trust and Deferred compensation employee stock trust,
respectively. Shares held by the trust at March 31, 2014,
2013 and 2012, were 672, 726 and 690, respectively.
12. EARNINGS PER SHARE
Basic 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 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 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
93
Legg Mason of the remaining $155,000 of a previously authorized share
repurchase program. The capital plan authorizes using up to
65% of cash generated from future operations to purchase
shares of Legg Mason common stock.
During the years ended March 31, 2014, 2013 and
2012, Legg Mason purchased and retired 9,677, 16,199
and 13,597 shares of its common stock, respectively,
for $359,996, $425,475 and $400,266, through open
market purchases. The fiscal 2013 purchases completed
the repurchase of its common stock under the previous
authorization and included approximately $270,000 of
purchases under the new authorization. These repurchases
reduced weighted-average shares outstanding by 4,908,
8,449, and 9,716 shares for the years ended March 31,
2014, 2013, and 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 June 2011, Legg Mason issued 1,830 shares of
common stock upon the exercise of purchase contracts on
the remaining outstanding Equity Units. Of these shares,
1,380 shares are included in weighted-average shares
outstanding for the year ended March 31, 2012.
The following table presents the computations of basic and diluted EPS:
Weighted-average basic shares outstanding
Potential common shares:
Employee stock options
Weighted-average diluted shares(1)
Net income (Loss)
Less: Net income (Loss) Attributable to noncontrolling interests
Net Income (Loss) Attributable to Legg Mason, Inc.
Net Income (Loss) per share Attributable to Legg Mason, Inc.
common shareholders
Basic
Diluted
(1) Diluted shares are the same as basic shares for periods with a net loss.
The diluted EPS calculations for the years ended March
31, 2014 and 2013, exclude any potential common shares
issuable under the 14,205 warrants issued in connection
with the repurchase of the 2.5% Convertible Senior Notes
in May 2012 because the market price of Legg Mason
common stock did not exceed the exercise price, and
therefore, the warrants would be antidilutive. The diluted
EPS calculations for the years ended March 31, 2013 and
2012, exclude any potential common shares issuable under
the 2.5% Convertible Senior 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, at March 31, 2012, 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 EPS because the effect would be antidilutive.
Options to purchase 2,620 and 5,239 shares for the years
ended March 31, 2014 and 2012, respectively, were
not included in the computation of diluted EPS because
the presumed proceeds from exercising such options,
94
Years Ended March 31
2014
121,941
442
122,383
$281,836
(2,948)
$284,784
2013
133,226
—
133,226
$(359,748)
(6,421)
$(353,327)
2012
143,292
57
143,349
$231,031
10,214
$220,817
$ 2.34
$ 2.33
$
$
(2.65)
(2.65)
$
$
1.54
1.54
including the related income tax benefits, exceed the
average price of the common shares for the period and
therefore the options are deemed antidilutive. Further,
market-based options are excluded from potential
dilution until the designated market condition is met.
The diluted EPS calculation for the year ended March 31,
2013, excludes 5,730 potential common shares that are
antidilutive due to the net loss for the fiscal year.
13. ACCUMULATED OTHER
COMPREHENSIVE INCOME
Accumulated other comprehensive income includes
cumulative foreign currency translation adjustments and
net of tax, gains and losses on investment securities. The
change in the accumulated translation adjustments for
fiscal 2014 and 2013, primarily resulted from the impact
of changes in the Brazilian real, the Australian dollar, the
Japanese yen, and the British pound in relation to the
U.S. dollar on the net assets of Legg Mason’s subsidiaries
in Brazil, Australia, Japan, and the U.K., for which the
real, the Australian dollar, the yen, and the pound are the
functional currencies, respectively.
Legg Mason A summary of Legg Mason’s accumulated other comprehensive income as of March 31, 2014 and 2013, is as follows:
Foreign currency translation adjustment
Unrealized gains on investment securities, net of tax provision of $76 and $187, respectively
Total
2014
$37,835
114
$37,949
2013
$47,259
280
$47,539
There were no significant amounts reclassified from
Accumulated other comprehensive income to the
Consolidated Statements of Income (Loss) for the years
ended March 31, 2014, 2013 or 2012.
14. DERIVATIVES AND HEDGING
The disclosures below detail Legg Mason’s derivatives and
hedging activities excluding the derivatives and hedging
activities of CIVs. See Note 17, 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, British pound, Japanese yen,
Australian dollar, euro, Singapore dollar, Chinese yuan,
Indonesian rupiah, Malaysian ringgit, Philippine peso, Thai
baht and South Korean won. In the Consolidated Balance
Sheets, Legg Mason nets the fair value of certain foreign
currency forwards or futures contracts executed with
the same counterparty where Legg Mason has both the
legal right and intent to settle the contracts on a net basis,
resulting in net Other assets of $1,249 and $1,158 as of
March 31, 2014 and 2013, respectively. Legg Mason has
not designated any derivatives as hedging instruments for
accounting purposes during the periods ended March 31,
2014 and 2013.
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 $12,985 and $7,131 as of March 31, 2014 and
2013, respectively.
The following table presents the fair values as of March 31, 2014 and 2013, of derivative instruments not designated for
accounting purposes as hedging instruments, classified as Other assets and Other liabilities:
Currency forward contracts
Futures and forward contracts
Total
2014
Assets
$3,271
313
$3,584
Liabilities
$ 825
1,510
$2,335
2013
Liabilities
$101
680
$781
Assets
$1,496
443
$1,939
The following table presents gains (losses) recognized on derivative instruments for the years ended March 31, 2014,
2013 and 2012. As described above, the currency, futures and forward contracts included below are economic hedges
of interest rate and market risk of certain operating and investing activities of Legg Mason. Gains and losses on these
derivatives substantially offset gains and losses of the hedged items.
Income Statement Classification
Gains
Losses
Gains
Losses
Gains
Losses
2014
2013
2012
Currency forward contracts for:
Operating activities
Other expense
$7,098
$ (2,617)
$3,650
$(1,858) $ 5,604 $(3,159)
Seed capital investments
Other non-operating income (expense)
56 (1,719)
1,090
(380)
431 (351)
Futures and forward contracts
for seed capital investments Other non-operating income (expense)
2,471 (19,403)
1,914
(5,597)
5,684
(4,560)
Total
$9,625 $(23,739)
$6,654
$(7,835) $11,719 $(8,070)
95
Legg Mason 15. 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
completed 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 $73,066 and $54,434 for the years ended
March 31, 2012 and 2011, respectively, which primarily
represent costs for lease loss accruals and fixed asset
accelerated depreciation related to space permanently
abandoned, as well as costs for severance and retention
incentives. There were no charges for transition-related
costs associated with this initiative for the years ended
March 31, 2014 or 2013.
The table below presents a summary of changes in the transition-related liability from March 31, 2011 through March 31, 2014:
Balance as of March 31, 2011
Accrued charges
Payments
Balance as of March 31, 2012
Payments and other
Balance as of March 31, 2013
Payments and other
Balance as of March 31, 2014
Severance
and Retention
Incentives
$ 23,211
29,096
(51,140)
1,167
(1,167)
—
—
Lease Loss
Accruals
and Other(1)
$ 5,835
25,916(2)
(16,121)
15,630
(10,744)
4,886
(3,276)
Total
$ 29,046
55,012
(67,261)
16,797
(11,911)
4,886
(3,276)
$ —
$ 1,610
$ 1,610
(1) Amounts related to the lease reserve liability are also included in Note 8.
(2) Includes lease loss accruals of $17,983 for space permanently abandoned.
See Note 2 for information regarding restructuring and
transition costs associated with the planned integration over
time of two existing affiliates, Batterymarch and LMGAA, in
conjunction with the acquisition of QS Investors.
16. BUSINESS SEGMENT INFORMATION
Legg Mason is a global asset management company that
provides investment management and related services
to a wide array of clients. The company operates in one
reportable business segment, Global Asset Management.
Global Asset Management provides investment advisory
services to institutional and individual clients and to
company-sponsored investment funds. The primary
sources of revenue in Global Asset Management are
investment advisory, distribution and administrative fees,
which typically are calculated as a percentage of the
AUM and vary based upon factors such as the type of
underlying investment product and the type of services
that are provided. In addition, performance fees may be
earned under certain investment advisory contracts for
exceeding performance benchmarks.
Revenues by geographic location are primarily based on
the geographic location of the advisor or the domicile of
fund families managed by Legg Mason.
96
Legg Mason The table below reflects our revenues and long-lived assets by geographic region as of March 31:
OPERATING REVENUES
United States
United Kingdom
Other International
Total
INTANGIBLE ASSETS, NET AND GOODWILL
United States
United Kingdom
Other International
Total
2014
2013
2012
$1,874,328
$1,800,539
$1,806,990
436,542
430,887
387,966
424,145
448,863
406,721
$2,741,757
$2,612,650
$2,662,574
$3,127,654
$3,139,050
$3,548,628
879,946
404,696
895,767
411,910
1,108,297
474,986
$4,412,296
$4,446,727
$5,131,911
17. VARIABLE INTEREST ENTITIES AND
CONSOLIDATION OF INVESTMENT VEHICLES
As further discussed in Notes 1 and 3, in accordance
with financial accounting standards on consolidation,
Legg Mason consolidates and separately identifies
certain sponsored investment vehicles as CIVs, the most
significant of which is a CLO. Legg Mason has concluded
that it was the primary beneficiary of one of three CLOs
in which it has a variable interest. As of March 31, 2014,
2013 and 2012, the balances related to this CLO were
consolidated and reported as a CIV in the Company’s
consolidated financial statements. In addition, Legg Mason
concluded it was the primary beneficiary of one sponsored
investment fund VIE, which was consolidated (and
designated a CIV) as of March 31, 2014, 2013 and 2012,
despite significant third party investments in this product.
As of March 31, 2014, Legg Mason also concluded it was
the primary beneficiary of 16 employee-owned funds it
sponsors, which were consolidated and reported as CIVs.
Finally, Legg Mason held a longer-term controlling financial
interest in one sponsored investment fund VRE, which has
third-party investors and was consolidated and included as
a CIV as of March 31, 2014, 2013 and 2012.
Legg Mason’s investment in CIVs as of March 31, 2014
and 2013, was $39,434 and $39,056, 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.
97
Legg Mason The following tables reflect the impact of CIVs on the Consolidated Balance Sheets as of March 31, 2014 and 2013, respectively,
and the Consolidated Statements of Income (Loss) for the years ended March 31, 2014, 2013 and 2012, respectively:
Consolidating Balance Sheets
March 31, 2014
March 31, 2013
Balance before
Consolidation
of CIVs
CIVs
Eliminations
Consolidated
Totals
Balance before
Consolidation
of CIVs
CIVs
Eliminations
Consolidated
Totals
Current assets
$2,032,827
$138,537
$(42,981)
$2,128,383
$1,908,932
$ 73,320
$(39,390)
$1,942,862
Non-current assets
4,950,948
32,018
—
4,982,966
5,115,181
211,617
—
5,326,798
Total assets
$6,983,775
$170,555
$(42,981)
$7,111,349
$7,024,113
$284,937
$(39,390)
$7,269,660
$ 735,737
$ 89,055
$ (3,547)
$ 821,245
$ 692,261
$ 10,539
$ (334)
$ 702,466
Current liabilities
Long-term debt
of CIVs
Other non-current
liabilities
1,520,236
—
—
—
—
—
—
—
207,835
1,520,236
1,517,069
2,930
—
—
207,835
1,519,999
Total liabilities
Redeemable
non-controlling
interests
Total stockholders’
equity
Total liabilities and
2,255,973
89,055
(3,547)
2,341,481
2,209,330
221,304
(334)
2,430,300
3,172
26,325
15,647
45,144
1,355
—
19,654
21,009
4,724,630
55,175
(55,081)
4,724,724
4,813,428
63,633
(58,710)
4,818,351
equity
$6,983,775
$170,555
$(42,981)
$7,111,349
$7,024,113
$284,937
$(39,390)
$7,269,660
98
Legg Mason Consolidating Statements of Income (Loss)
Total operating revenues
Total operating expenses
Operating income (loss)
Total other non-operating income (expense)
Income before income tax provision (benefit)
Income tax provision (benefit)
Net income
Less: Net income (loss) attributable to noncontrolling interests
Year Ended March 31, 2014
Balance before
Consolidation of CIVs
CIVs
Eliminations
As Reported
$2,743,707
2,310,444
433,263
(10,333)
422,930
137,805
285,125
341
$ —
2,376
(2,376)
2,445
69
—
69
—
$(1,950)
(1,956)
6
(3,364)
(3,358)
—
(3,358)
(3,289)
$2,741,757
2,310,864
430,893
(11,252)
419,641
137,805
281,836
(2,948)
Net income attributable to Legg Mason, Inc.
$ 284,784
$ 69
$ (69)
$ 284,784
Total operating revenues
Total operating expenses
Operating income (loss)
Total other non-operating income (expense)
Income (loss) before income tax provision (benefit)
Income tax provision (benefit)
Net income (loss)
Less: Net income (loss) attributable to noncontrolling interests
Balance before
Consolidation of CIVs
$2,615,047
3,046,587
(431,540)
(72,177)
(503,717)
(150,859)
(352,858)
469
Year Ended March 31, 2013
CIVs
$ —
2,965
(2,965)
(2,864)
(5,829)
—
(5,829)
—
Eliminations
As Reported
$(2,397)
(2,403)
6
(1,067)
(1,061)
—
(1,061)
(6,890)
$2,612,650
3,047,149
(434,499)
(76,108)
(510,607)
(150,859)
(359,748)
(6,421)
Net income (loss) attributable to Legg Mason, Inc.
$ (353,327)
$(5,829)
$ 5,829
$ (353,327)
Total operating revenues
Total operating expenses
Operating income (loss)
Total other non-operating income (expense)
Income (loss) before income tax provision (benefit)
Income tax provision (benefit)
Net income (loss)
Less: Net income (loss) attributable to noncontrolling interests
Balance before
Consolidation of CIVs
$2,665,668
2,323,213
342,455
(49,236)
293,219
72,052
221,167
350
Net income (loss) attributable to Legg Mason, Inc.
$ 220,817
Year Ended March 31, 2012
CIVs
$ —
3,709
(3,709)
18,336
14,627
—
14,627
—
$14,627
Eliminations
As Reported
$ (3,094)
$2,662,574
(3,101)
2,323,821
7
(4,770)
(4,763)
—
(4,763)
9,864
338,753
(35,670)
303,083
72,052
231,031
10,214
$(14,627)
$ 220,817
Other non-operating income (expense) includes interest income, interest expense and net gains (losses) on investments
and long-term debt determined on an accrual basis.
The consolidation of CIVs has no impact on Net Income (Loss) Attributable to Legg Mason, Inc.
99
Legg Mason The fair value of the financial assets and (liabilities) of CIVs were determined using the following categories of inputs:
Quoted Prices
in Active
Markets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Value as of
March 31,
2014
$ 1,110
27,524
28,634
—
$28,634
$ —
—
$ —
$ 3,941
—
3,941
—
$ 3,941
$ —
(1,888)
$(1,888)
$ 17,888
—
17,888
31,810
$ 49,698
$(79,179)
—
$(79,179)
$ 22,939
27,524
50,463
31,810
$ 82,273
$(79,179)
(1,888)
$(81,067)
Quoted Prices
in Active
Markets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Value as of
March 31,
2013
$2,076
$ 3,268
$ 19,448
$ 24,792
—
—
—
—
$2,076
$ —
—
$ —
172,519
11,052
—
183,571
$186,839
$ —
(2,930)
$ (2,930)
—
—
26,982
26,982
$ 46,430
$(207,835)
—
$(207,835)
172,519
11,052
26,982
210,553
$ 235,345
$(207,835)
(2,930)
$(210,765)
ASSETS:
Trading investments:
Hedge funds
Proprietary funds
Total trading investments
Investments:
Private equity funds
LIABILITIES:
CLO debt
Derivative liabilities
ASSETS:
Trading investments:
Hedge funds
Investments:
CLO loans
CLO bonds
Private equity funds
Total investments
LIABILITIES:
CLO debt
Derivative liabilities
100
Legg Mason Except for the CLO debt, substantially all of the above financial instruments where valuation methods rely on other than
observable market inputs as a significant input utilize the NAV practical expedient, such that measurement uncertainty
has little relevance. In April 2014, the CLO was completing its wind-down for the subsequent distribution of cash to
settle its liabilities. As of March 31, 2014, the carrying value of the CLO debt approximated the amount to be paid to
investors, and there was no appreciable measurement uncertainty. The following table provides a summary of qualitative
information relating to the valuation of CLO debt as of March 31, 2013:
Value as of
March 31, 2013
Valuation technique
Unobservable input
Range (weighted-average)
$(207,835)
Discounted cash flow
Discount rate
Default rate
1.1%–11.0% (2.3%)
3.0%–4.0% (3.5%)
Constant prepayment rate
25.0%
The changes in assets and (liabilities) of CIVs measured at fair value using significant unobservable inputs (Level 3) for the
years ended March 31, 2014 and 2013 are presented in the table below:
Value as of
March 31,
2013
Purchases
Sales
Settlements/
Other
Transfers
Realized and
Unrealized
Gains/
(Losses), Net
Value as of
March 31,
2014
ASSETS:
Hedge funds
$ 19,448
$3,516
$(8,037)
$ —
Private equity funds
26,982
1,811
—
—
$ 46,430
$5,327
$(8,037)
$ —
$ —
—
$ —
$ 2,961
3,017
$ 5,978
$ 17,888
31,810
$ 49,698
LIABILITIES:
CLO debt
Total realized and unrealized
gains (losses), net
ASSETS:
Hedge funds
Private equity funds
LIABILITIES:
CLO debt
Total realized and unrealized
gains (losses), net
$(207,835)
$ —
$ —
$133,047
$ —
$(4,391)
$(79,179)
Value as of
March 31,
2012
Purchases
Sales
Settlements/
Other
Transfers
$ 1,587
Realized and
Unrealized
Gains/
(Losses), Net
Value as of
March 31,
2013
$ 24,116
25,071
$ 49,187
$1,980
2,622
$4,602
$(6,602)
$ —
(2,030)
—
$(8,632)
$ —
$ —
—
$ —
$ (46)
$ 19,448
1,319
26,982
$ 1,273
$ 46,430
$(271,707)
$ —
$ —
$75,798
$ —
$(11,926)
$(207,835)
$(10,653)
101
Legg Mason Realized and unrealized gains and losses recorded for Level 3 assets and liabilities of CIVs are included in Other non-
operating income (expense) of CIVs on the Consolidated Statements of Income (Loss). Total unrealized losses for Level 3
investments and liabilities of CIVs relating only to those assets and liabilities still held at the reporting date were $2,284
and $11,842 for the years ended March 31, 2014 and 2013, respectively.
There were no transfers between Level 1 and Level 2 during either of the years ended March 31, 2014 and 2013.
The NAVs used as a practical expedient by CIVs have been provided by the investees and have been derived from the fair
values of the underlying investments as of the respective reporting dates. The following table summarizes, as of March
31, 2014 and March 31, 2013, the nature of these investments and any related liquidation restrictions or other factors
which may impact the ultimate value realized:
Category of
Investment
Hedge funds
Investment Strategy
Global macro, fixed income, long/short
equity, systematic, emerging market,
U.S. and European hedge
Fair Value Determined Using NAV
As of March 31, 2014
March 31,
2014
March 31,
2013
Unfunded
Commitments
Remaining
Term
$22,939(1)
$24,792(2)
n/a
n/a
Private equity funds
Long/short equity
Total
31,810(3)
26,982(3)
$54,749
$51,774
$2,707
$2,707
4 years
n/a—not applicable
(1) 10% daily redemption; 6% monthly redemption; 2% quarterly redemption; and 82% are subject to three to five year lock-up or side pocket provisions.
(2) 11% daily redemption; 8% monthly redemption; 2% quarterly redemption; and 79% are subject to three to five year lock-up or side pocket provisions.
(3) Liquidations are expected over the remaining term.
There are no current plans to sell any of these investments held as of March 31, 2014.
Legg Mason has elected the fair value option for certain eligible assets and liabilities, including corporate loans and debt,
of the consolidated CLO. Management believes that the use of the fair value option mitigates the impact of certain timing
differences and better matches the changes in fair value of assets and liabilities related to the CLO.
The following table presents the fair value and unpaid principal balance of CLO loans, bonds and debt carried at fair value
under the fair value option as of March 31, 2014 and March 31, 2013:
CLO loans and bonds
Unpaid principal balance
Unpaid principal balance in excess of fair value
Fair value
CLO debt
Principal amounts outstanding
Excess unpaid principal over fair value
Fair value
March 31, 2014
March 31, 2013
$ —
—
$ —
$ 92,114
(12,935)
$ 79,179
$186,839
(3,268)
$183,571
$225,161
(17,326)
$207,835
During the years ended March 31, 2014 and 2013, total net losses of $5,914 and $8,455, respectively, were recognized
in Other non-operating income (loss) of CIVs in the Consolidated Statements of Income (Loss) related to assets and
liabilities for which the fair value option was elected. CLO loans and CLO debt measured at fair value have floating interest
rates, therefore, substantially all of the estimated gains and losses included in earnings for the years ended March 31,
2014 and 2013, were attributable to instrument specific credit risk.
102
Legg Mason The CLO debt bears interest at variable rates based on LIBOR plus a pre-defined spread, which ranges from 25 basis
points to 400 basis points. All outstanding debt matures on July 15, 2018. The CLO commenced its wind-down in July
2012, such that proceeds from securities cannot be reinvested and are applied to reduce the debt outstanding in the
quarter subsequent to receipt, after other required payments. As noted above, the CLO was completing its wind-down in
April 2014.
Total derivative liabilities of CIVs of $1,888 and $2,930 as of March 31, 2014 and 2013, respectively, are recorded in
Other liabilities of CIVs. Gains and (losses) of $1,311 and $(1,537), respectively, for the fiscal year ended March 31, 2014
and $942 and $(1,223), respectively, for the fiscal year ended March 31, 2013, related to derivative liabilities of CIVs are
included in Other non-operating income (loss) of CIVs. There is no risk to Legg Mason in relation to the derivative assets
and liabilities of the CIVs in excess of its investment in the funds, if any.
As of March 31, 2014 and 2013, for VIEs in which Legg Mason holds a variable interest or is the sponsor and holds a
variable interest, but for which it was not the primary beneficiary, Legg Mason’s carrying value and maximum risk of loss
were as follows:
CLOs
Real Estate Investment Trust
Other sponsored investment funds
Total
As of March 31, 2014
As of March 31, 2013
Equity Interests on
the Consolidated
Balance Sheet(1)
Maximum Risk
of Loss(2)
Equity Interests on
the Consolidated
Balance Sheet(1)
Maximum Risk
of Loss(2)
$ —
1,442
34,126
$35,568
$ 911
3,715
78,521
$83,147
$ —
989
43,104
$44,093
$ 496
2,644
87,121
$90,261
(1) Includes $23,404 and $33,918 related to investments in proprietary funds products as of March 31, 2014 and 2013, respectively.
(2) Includes equity investments the Company has made or is required to make and any earned but uncollected management fees.
The Company’s total AUM of unconsolidated VIEs was $16,032,764 and $17,090,267 as of March 31, 2014
and 2013, respectively.
The assets of these VIEs are primarily comprised of cash and cash equivalents and investment securities, and the
liabilities are primarily comprised of debt and various expense accruals. These VIEs are not consolidated because either
(1) Legg Mason does not have the power to direct significant economic activities of the entity and rights/obligations
associated with benefits/losses that could be significant to the entity, or (2) Legg Mason does not absorb a majority of
each VIE’s expected losses or does not receive a majority of each VIE’s expected residual gains.
103
Legg Mason Quarterly Financial Data
(Dollars in thousands, except per share amounts or unless otherwise noted)
(Unaudited)
Fiscal 2014(1)
Operating Revenues
Operating Expenses
Operating Income
Other Non-Operating Income (Expense)
Income before Income Tax Provision
Income tax provision
Net Income
Less: Net income (Loss) attributable to noncontrolling interests
Quarter Ended
Mar. 31
$681,396
Dec. 31
$720,092
562,055
119,341
(7,393)
111,948
46,856
65,092
(3,855)
598,440
121,652
4,303
125,955
46,004
79,951
(1,783)
Sept. 30
$669,852
563,486
106,366
485
106,851
19,153
87,698
1,410
June 30
$670,417
586,883
83,534
(8,647)
74,887
25,792
49,095
1,280
Net Income Attributable to Legg Mason, Inc.
$ 68,947
$ 81,734
$ 86,288
$ 47,815
Net Income per Share Attributable to Legg Mason, Inc.
common shareholders:
Basic
Diluted
Cash dividend per share
Stock price range:
High
Low
Assets Under Management (in millions):
End of period
Average
$ 0.58
$ 0.68
$ 0.70
$ 0.38
0.58
0.13
49.50
39.60
0.67
0.13
44.09
32.44
0.70
0.13
35.85
30.28
0.38
0.13
37.04
29.28
$701,774
689,003
$679,475
670,019
$656,023
650,428
$644,511
654,737
(1) Due to rounding of quarterly results, total amounts for fiscal year may differ immaterially from the annual results.
As of May 20, 2014, the closing price of Legg Mason’s common stock was $48.11.
Fiscal 2013(1)
Operating Revenues
Operating Expenses
Operating Income (Loss)
Other Non-Operating Income (Expense)
Income (Loss) before Income Tax Provision (Benefit)
Income tax provision (benefit)
Net Income (Loss)
Less: Net income (loss) attributable to noncontrolling interests
Quarter Ended
Mar. 31
$667,763
624,750
Dec. 31
$ 673,900
1,307,223
Sept. 30
$640,295
560,561
June 30
$630,692
554,615
43,013
5,633
48,646
17,955
30,691
1,487
(633,323)
(5,441)
(638,764)
(180,214)
(458,550)
(4,680)
79,734
17,758
97,492
16,397
81,095
298
76,077
(94,058)
(17,981)
(4,997)
(12,984)
(3,526)
Net Income (Loss) Attributable to Legg Mason, Inc.
$ 29,204
$ (453,870)
$ 80,797
$ (9,458)
Net Income (Loss) per share attributable to Legg Mason, Inc.
common shareholders:
Basic
Diluted
Cash dividend per share
Stock price range:
High
Low
Assets Under Management (in millions):
End of period
Average
$ 0.23
$ (3.45)
$ 0.60
$ (0.07)
0.23
0.11
32.59
25.43
(3.45)
0.11
26.63
23.88
0.60
0.11
27.14
23.31
(0.07)
0.11
28.47
22.36
$664,609
657,357
$648,879
648,354
$650,700
639,389
$631,823
635,463
(1) Due to rounding of quarterly results, total amounts for fiscal year may differ immaterially from the annual results.
104
Legg Mason Executive Officers
Corporate Data
Joseph A. Sullivan
President and Chief Executive Officer
Peter H. Nachtwey
Senior Executive Vice President and
Chief Financial Officer
EXECUTIVE OFFICES
100 International Drive
Baltimore, Maryland 21202
(410) 539-0000
www.leggmason.com
TRANSFER AGENT
American Stock Transfer & Trust Company
6201 15th Avenue
Brooklyn, NY 11219
(212) 936-5100
www.amstock.com
Thomas K. Hoops
Executive Vice President and
Head of Business Development
Terence A. Johnson
Executive Vice President and
Head of Global Distribution
Thomas C. Merchant
Executive Vice President and
General Counsel
Jennifer W. Murphy
Executive Vice President and
Chief Administrative Officer
FORM 10-K
Legg Mason’s Annual Report on Form 10-K
for fiscal 2014, filed with the Securities
COMMON STOCK
Shares of Legg Mason, Inc. common
and Exchange Commission and containing
stock are listed and traded on the New
audited financial statements, is available
York Stock Exchange (symbol: LM).
upon request without charge by writing to
As of March 31, 2014, there were 1,300
the Corporate Secretary at the Executive
shareholders of record of the Company’s
Offices of the Company.
common stock.
Copies can also be obtained by accessing
our website at www.leggmason.com
INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
PricewaterhouseCoopers LLP
100 E. Pratt Street
Baltimore, Maryland 21202
(410) 783-7600
www.pwc.com
Total Return Performance
The graph below compares the cumulative total stockholder return on Legg Mason’s common stock for the last five fiscal years with the
cumulative total return of the S&P 500 Stock Index and the SNL Asset Manager Index over the same period (assuming the investment of
$100 in each on March 31, 2009). The SNL Asset Manager Index consists of 35 asset management firms.
E
U
L
A
V
X
E
D
N
I
400
300
200
100
0
03/31/09
03/31/10
03/31/11
03/31/12
03/31/13
03/31/14
LEGG MASON, INC.
SNL ASSET MANAGER INDEX
S&P 500
P E R I O D E N D I N G
INDEX
03/31/09
03/31/10 03/31/11
03/31/12
03/31/13
03/31/14
Legg Mason, Inc.
100.00 181.10 229.31 179.55
210.15
324.97
SNL Asset Manager Index
100.00 184.57 216.01 211.14
271.17
341.34
S&P 500
100.00 149.77 173.20 187.99
214.24 261.07
Source: SNL Financial LC, Charlottesville, VA
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INDEPENDENT EXPERTISE.
SINGULAR FOCUS.®
leggmason.com
youtube.com/leggmason
linkedin.com/company/legg-mason
@leggmason
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