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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
 
FORM 10-Q
(Mark One)
[x]  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2018
OR
[ ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from
 
 
 
to
 
Commission file number: 1-8529
394529776_imageleggmasona08.jpg
LEGG MASON, INC.
(Exact name of registrant as specified in its charter)
 
 
 
MARYLAND
 
52-1200960
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
100 International Drive - Baltimore, MD
 
21202
(Address of principal executive offices)
 
(Zip code)
 
 
 
(410) 539-0000
(Registrant’s telephone number, including area code)
 
 
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes
X
 
No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). 
Yes
X
 
No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
X
 
Accelerated filer
 
Non-accelerated filer
 
(Do not check if a smaller reporting company)
Smaller reporting company
 
Emerging growth company
 
 
 
 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ____

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes
 
 
No
X

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
85,451,070 shares of common stock as of the close of business on August 2, 2018.


Table of Contents

TABLE OF CONTENTS
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



Table of Contents

PART I. FINANCIAL INFORMATION

Item 1.        Financial Statements

LEGG MASON, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
(Unaudited)
 
 
June 30, 2018
 
March 31, 2018
ASSETS
 
 
 
 
Current Assets
 
 
 
 
Cash and cash equivalents
 
$
590,530

 
$
736,130

Cash and cash equivalents of consolidated investment vehicles
 
3,466

 
2,800

Restricted cash
 
19,004

 
30,428

Receivables:
 


 
 
Investment advisory and related fees
 
435,620

 
475,594

Other
 
55,827

 
77,024

Investment securities
 
392,296

 
399,370

Investment securities of consolidated investment vehicles
 
164,468

 
140,133

Other
 
74,958

 
65,010

Other current assets of consolidated investment vehicles
 
2,609

 
1,893

Total Current Assets
 
1,738,778

 
1,928,382

Fixed assets, net
 
154,315

 
148,406

Intangible assets, net
 
3,777,315

 
3,797,659

Goodwill
 
1,901,926

 
1,932,355

Deferred income taxes
 
199,431

 
202,068

Other
 
145,063

 
134,407

Other assets of consolidated investment vehicles
 
9,413

 
9,257

TOTAL ASSETS
 
$
7,926,241

 
$
8,152,534

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
 
LIABILITIES
 
 

 
 

Current Liabilities
 
 

 
 

Accrued compensation
 
$
260,089

 
$
476,061

Accounts payable and accrued expenses
 
191,901

 
175,583

Short-term borrowings
 
125,500

 
125,500

Contingent consideration
 
4,174

 
3,707

Other
 
138,019

 
200,557

Other current liabilities of consolidated investment vehicles
 
629

 
634

Total Current Liabilities
 
720,312

 
982,042

Deferred compensation
 
101,258

 
92,422

Deferred income taxes
 
155,990

 
139,787

Contingent consideration
 
1,900

 
1,900

Other
 
121,572

 
130,142

Long-term debt, net
 
2,221,796

 
2,221,810

TOTAL LIABILITIES
 
3,322,828

 
3,568,103

Commitments and Contingencies (Note 7)
 
 
 
 
REDEEMABLE NONCONTROLLING INTERESTS
 
747,697

 
732,295

STOCKHOLDERS' EQUITY
 
 

 
 
Common stock, par value $.10; authorized 500,000,000 shares; issued 85,440,021 shares for June 2018 and 84,606,408 shares for March 2018
 
8,544

 
8,461

Additional paid-in capital
 
1,984,634

 
1,976,364

Employee stock trust
 
(21,952
)
 
(21,996
)
Deferred compensation employee stock trust
 
21,952

 
21,996

Retained earnings
 
1,941,988

 
1,894,762

Accumulated other comprehensive loss, net
 
(107,662
)
 
(55,182
)
Total stockholders' equity attributable to Legg Mason, Inc.
 
3,827,504

 
3,824,405

Nonredeemable noncontrolling interest
 
28,212

 
27,731

TOTAL STOCKHOLDERS' EQUITY
 
3,855,716

 
3,852,136

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
 
$
7,926,241

 
$
8,152,534

See Notes to Consolidated Financial Statements

3

Table of Contents

LEGG MASON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except per share amounts)
(Unaudited)
 
 
Three Months Ended June 30,
 
 
2018
 
2017
OPERATING REVENUES
 
 
 
 
Investment advisory fees:
 
 
 
 
Separate accounts
 
$
259,895

 
$
250,046

Funds
 
383,564

 
382,228

Performance fees
 
24,036

 
81,537

Distribution and service fees
 
79,190

 
78,906

Other
 
1,220

 
1,125

Total Operating Revenues
 
747,905

 
793,842

OPERATING EXPENSES
 
 
 
 
Compensation and benefits
 
361,568

 
413,307

Distribution and servicing
 
116,592

 
122,349

Communications and technology
 
56,740

 
50,303

Occupancy
 
24,904

 
24,408

Amortization of intangible assets
 
6,180

 
6,339

Impairment of intangible assets
 

 
34,000

Contingent consideration fair value adjustments
 
426

 
(16,550
)
Other
 
55,819

 
52,481

Total Operating Expenses
 
622,229

 
686,637

OPERATING INCOME
 
125,676

 
107,205

NON-OPERATING INCOME (EXPENSE)
 
 
 
 
Interest income
 
2,446

 
1,468

Interest expense
 
(29,917
)
 
(29,266
)
Other income, net
 
7,252

 
11,388

Non-operating income of consolidated investment vehicles, net
 
3,583

 
997

Total Non-Operating Income (Expense)
 
(16,636
)
 
(15,413
)
INCOME BEFORE INCOME TAX PROVISION
 
109,040

 
91,792

Income tax provision
 
30,675

 
28,255

NET INCOME
 
78,365

 
63,537

Less: Net income attributable to noncontrolling interests
 
12,275


12,617

NET INCOME ATTRIBUTABLE TO LEGG MASON, INC.
 
$
66,090

 
$
50,920

 
 
 
 
 
NET INCOME PER SHARE ATTRIBUTABLE TO LEGG MASON, INC. SHAREHOLDERS:
 
 
 
 
Basic
 
$
0.75

 
$
0.52

Diluted
 
0.75

 
0.52

 
 
 
 
 
DIVIDENDS DECLARED PER SHARE
 
$
0.34

 
$
0.28

See Notes to Consolidated Financial Statements

4

Table of Contents

LEGG MASON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Dollars in thousands)
(Unaudited)
 
 
Three Months Ended June 30,
 
 
2018
 
2017
NET INCOME
 
$
78,365

 
$
63,537

Other comprehensive income (loss):
 
 
 
 
Foreign currency translation adjustment
 
(53,362
)
 
10,671

Changes in defined benefit pension plan
 
882

 
119

Total other comprehensive income (loss)
 
(52,480
)
 
10,790

COMPREHENSIVE INCOME
 
25,885

 
74,327

Less: Comprehensive income attributable to noncontrolling interests
 
14,884

 
12,284

COMPREHENSIVE INCOME ATTRIBUTABLE TO LEGG MASON, INC.
 
$
11,001

 
$
62,043

See Notes to Consolidated Financial Statements

5

Table of Contents

LEGG MASON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(Dollars in thousands)
(Unaudited)
 
 
Three Months Ended June 30,
 
 
2018
 
2017
STOCKHOLDERS' EQUITY ATTRIBUTABLE TO LEGG MASON, INC.
 
 
 
 
COMMON STOCK
 
 
 
 
Beginning balance
 
$
8,461

 
$
9,573

Stock options exercised
 
15

 
26

Deferred compensation employee stock trust
 

 
1

Stock-based compensation
 
107

 
83

Employee tax withholdings by settlement of net share transactions
 
(39
)
 
(34
)
Shares repurchased and retired
 

 
(237
)
Ending balance
 
8,544

 
9,412

ADDITIONAL PAID-IN CAPITAL
 
 
 
 

Beginning balance
 
1,976,364

 
2,385,726

Stock options exercised
 
4,801

 
7,380

Deferred compensation employee stock trust
 
136

 
125

Stock-based compensation
 
18,701

 
20,710

Employee tax withholdings by settlement of net share transactions
 
(15,368
)
 
(12,777
)
Shares repurchased and retired
 

 
(89,412
)
Ending balance
 
1,984,634

 
2,311,752

EMPLOYEE STOCK TRUST
 
 
 
 

Beginning balance
 
(21,996
)
 
(24,057
)
Shares issued to plans
 
(136
)
 
(126
)
Distributions and forfeitures
 
180

 
61

Ending balance
 
(21,952
)
 
(24,122
)
DEFERRED COMPENSATION EMPLOYEE STOCK TRUST
 
 
 
 

Beginning balance
 
21,996

 
24,057

Shares issued to plans
 
136

 
126

Distributions and forfeitures
 
(180
)
 
(61
)
Ending balance
 
21,952

 
24,122

RETAINED EARNINGS
 
 
 
 

Beginning balance
 
1,894,762

 
1,694,859

Net Income (Loss) Attributable to Legg Mason, Inc.
 
66,090

 
50,920

Dividends declared
 
(29,858
)
 
(27,352
)
Reclassification to noncontrolling interest for net increase in estimated redemption value of affiliate management equity plans and affiliate noncontrolling interests
 
(1,269
)
 
(1,392
)
Adoption of new revenue recognition guidance
 
12,263

 

Adoption of new stock-based compensation guidance
 

 
24,327

Ending balance
 
1,941,988

 
1,741,362

ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS), NET
 
 
 
 

Beginning balance
 
(55,182
)
 
(106,784
)
Changes in defined benefit pension plan
 
882

 
119

Foreign currency translation adjustment
 
(53,362
)
 
10,671

Ending balance
 
(107,662
)
 
(95,994
)
TOTAL STOCKHOLDERS’ EQUITY ATTRIBUTABLE TO LEGG MASON, INC.
 
3,827,504


3,966,532

NONREDEEMABLE NONCONTROLLING INTEREST
 
 
 
 
Beginning balance
 
27,731

 
27,798

Net income attributable to noncontrolling interests
 
2,214

 
2,261

Distributions
 
(1,733
)
 
(1,818
)
Ending balance
 
28,212

 
28,241

TOTAL STOCKHOLDERS’ EQUITY
 
$
3,855,716

 
$
3,994,773

See Notes to Consolidated Financial Statements

6

Table of Contents

LEGG MASON, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)
 
 
Three Months Ended June 30,
 
 
2018
 
2017
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
 
 
Net Income (Loss)
 
$
78,365

 
$
63,537

Adjustments to reconcile Net Income to net cash provided by operations:
 
 
 
 

Impairments of intangible assets
 

 
34,000

Depreciation and amortization
 
17,547

 
18,473

Accretion and amortization of securities discounts and premiums, net
 
561

 
936

Stock-based compensation
 
19,085

 
21,068

Net unrealized (gains) losses on investments
 
(350
)
 
(5,496
)
Net (gains) losses and earnings on investments
 
(6,792
)
 
(5,546
)
Net (gains) losses of consolidated investment vehicles
 
(3,583
)
 
(997
)
Deferred income taxes
 
21,796

 
22,183

Contingent consideration fair value adjustments
 
426

 
(16,550
)
Other
 
371

 
(76
)
Decrease (increase) in assets:
 
 
 
 

Investment advisory and related fees receivable
 
36,589

 
(46,340
)
Net sales (purchases) of trading and other investments
 
(4,385
)
 
39,438

Other receivables
 
(4,473
)
 
(9,778
)
Other assets
 
(12,562
)
 
(1,330
)
Assets of consolidated investment vehicles
 
(14,575
)
 
(32,775
)
Increase (decrease) in liabilities:
 
 
 
 

Accrued compensation
 
(213,181
)
 
(201,486
)
Deferred compensation
 
8,837

 
15,718

Accounts payable and accrued expenses
 
18,166

 
12,378

Other liabilities
 
(44,007
)
 
(23,855
)
Other liabilities of consolidated investment vehicles
 
(5
)
 
1,014

CASH USED IN OPERATING ACTIVITIES
 
$
(102,170
)
 
$
(115,484
)










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

 
 
Three Months Ended June 30,
 
 
2018
 
2017
CASH FLOWS FROM INVESTING ACTIVITIES
 
 
 
 
Payments for fixed assets
 
$
(17,990
)
 
$
(8,371
)
Contingent payment from prior sale of businesses
 

 
2,561

Returns of capital and proceeds from sales and maturities of investments
 
3,679

 
2,132

CASH USED IN INVESTING ACTIVITIES
 
(14,311
)
 
(3,678
)
CASH FLOWS FROM FINANCING ACTIVITIES
 
 
 
 
Dividends paid
 
(24,572
)
 
(21,153
)
Distributions to affiliate noncontrolling interests
 
(13,183
)
 
(17,731
)
Net subscriptions (redemptions) attributable to noncontrolling interests
 
18,132


10,266

Employee tax withholdings by settlement of net share transactions
 
(15,407
)
 
(12,811
)
Issuances of common stock for stock-based compensation
 
4,952

 
7,532

Repurchases of common stock
 

 
(89,649
)
CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES
 
(30,078
)
 
(123,546
)
EFFECT OF EXCHANGE RATES
 
(10,062
)
 
(412
)
NET DECREASE IN CASH, CASH EQUIVALENTS, AND RESTRICTED CASH
 
(156,621
)
 
(243,120
)
CASH, CASH EQUIVALENTS, AND RESTRICTED CASH:
 
 
 
 
BEGINNING OF PERIOD
 
773,765

 
754,339

END OF PERIOD
 
$
617,144

 
$
511,219

Supplemental Disclosures
 
 
 
 
Cash paid for:
 
 
 
 

Income taxes, net of refunds of $1,903 in 2017
 
$
13,269

 
$
8,132

Interest
 
$
12,135

 
$
11,094

 
 
 
 
 
Reconciliation of cash, cash equivalents and restricted cash
 
 
 
 
Cash and cash equivalents
 
$
590,530

 
$
491,301

Restricted cash
 
19,004

 
15,152

Cash and cash equivalents of consolidated investment vehicles
 
3,466

 
679

Affiliate employee benefit trust cash included in Other non-current assets
 
4,144

 
4,087

Total cash, cash equivalents and restricted cash per consolidated statements of cash flows
 
$
617,144

 
$
511,219

See Notes to Consolidated Financial Statements

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Table of Contents

LEGG MASON, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts or unless otherwise noted)
June 30, 2018
(Unaudited)

1. Interim Basis of Reporting

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

The nature of Legg Mason's business is such that the results of any interim period are not necessarily indicative of the results of a full year. Certain disclosures included in the Company's annual report are not required to be included on an interim basis in the Company's quarterly reports on Form 10-Q. The Company has condensed or omitted these disclosures. Certain amounts in prior period financial statements have been reclassified to conform to new guidance and the current period presentation, including the classification and presentation of restricted cash and certain distributions received from equity method investees in the Consolidated Statements of Cash Flows, as discussed below.

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

2. Significant Accounting Policies

Consolidation
In the normal course of its business, Legg Mason sponsors and manages various types of investment products. 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, except those for which total return swap arrangements have been executed, for which additional risks are discussed below. Legg Mason did not sell or transfer investment assets to any of these investment products. In accordance with financial accounting standards, Legg Mason consolidates certain sponsored investment products, some of which are designated and reported as consolidated investment vehicles ("CIVs"). The consolidation of sponsored investment products, including those designated as CIVs, has no impact on Net Income Attributable to Legg Mason, Inc. and does not have a material impact on Legg Mason's consolidated operating results. The change in the value of all consolidated sponsored investment products is recorded in Non-Operating Income (Expense) and reflected in Net income (loss) attributable to noncontrolling interests. The financial information of certain consolidated sponsored investment products is included in the Company's Consolidated Financial Statements on a three-month lag based upon the availability of the investment product's financial information.

Certain of the investment products Legg Mason sponsors and manages are considered to be variable interest entities ("VIEs") (as further described below) while others are considered to be voting rights entities (“VREs”) subject to traditional consolidation concepts based on ownership rights. Legg Mason may fund the initial cash investment in certain VRE investment products 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 in Note 3, the products with “seed capital investments” are consolidated as long as Legg Mason maintains a controlling financial interest in the product, but they are not designated as CIVs by Legg Mason unless the investment is longer-term. As of June 30, 2018, March 31, 2018, and June 30, 2017, no consolidated VREs were designated as CIVs.


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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 investors for a potential controlling financial interest. Legg Mason must consolidate any VIE for which it is deemed to be the primary beneficiary.

Under consolidation accounting guidance, if limited partners or similar equity holders in a sponsored investment vehicle structured as a limited partnership or a similar entity do not have either substantive investor rights to replace the manager (kick-out rights) or substantive participation rights over the general partner, the entities are VIEs. As a sponsor and manager of an investment vehicle, Legg Mason may be deemed a decision maker under the accounting guidance. If the fees paid to a decision maker are market-based, such fees are not considered variable interests in a VIE. Market-based fees are those fees which are both customary and commensurate with the level of effort required for the services provided. Additionally, if employee interests in a sponsored investment vehicle are not made to circumvent the consolidation guidance and are not financed by the sponsor, they are not included in the variable interests assessment, and are not included in the primary beneficiary determination.

A decision maker is deemed to be a primary beneficiary of a VIE if it has the power to direct activities that most significantly impact the economic performance of the VIE and the obligation to absorb losses or receive benefits from variable interests that could be significant to the VIE. In determining whether it is the primary beneficiary of a VIE, Legg Mason considers both qualitative and quantitative factors such as the voting rights of the equity holders, guarantees, and implied relationships. If a fee paid to a decision maker is not market-based, it will be considered in the primary beneficiary determination.

As of June 30, 2018, March 31, 2018 and June 30, 2017, Legg Mason concluded it was the primary beneficiary of certain VIEs, which were consolidated and designated as CIVs, because it held significant financial interests in the funds. In addition, Legg Mason has entered into various total return swap arrangements with financial intermediaries with respect to two Legg Mason sponsored exchange traded funds ("ETFs"). Under the terms of the total return swaps, Legg Mason absorbs all gains and losses on the underlying ETF investments of these financial intermediaries, and therefore has variable interests in each of the two related funds and is deemed to be the primary beneficiary. As of June 30, 2018 and March 31, 2018, Legg Mason consolidated each of the two ETFs, which were designated as CIVs. As of June 30, 2017, Legg Mason consolidated only one of the ETFs, which was designated as a CIVs, as the total return swaps related to the second ETF had not yet been executed.

Revenue Recognition
Effective April 1, 2018, Legg Mason adopted updated accounting guidance on revenue recognition which provides a single, comprehensive revenue recognition model for all contracts with customers, improves comparability and removes inconsistencies in revenue recognition practices across entities, industries, jurisdictions, and capital markets. The guidance also specifies the accounting for certain costs to obtain or fulfill a contract with a customer and revises the criteria for determining if an entity is acting as a principal or agent in certain arrangements. The adoption of the updated guidance did not result in significant changes to Legg Mason’s prior revenue recognition practices, except for the timing of the recognition of certain performance and incentive fees, the capitalization and amortization of certain sales commissions for separate accounts, and the net presentation of certain fund expense reimbursements which were previously presented on a gross basis. Each of these changes to Legg Mason’s previous revenue recognition practices is further discussed below.
Legg Mason adopted the updated guidance on a modified retrospective basis for any contracts that were not complete as of April 1, 2018, and recognized the cumulative effect of initially applying the updated guidance for certain sales commissions as an adjustment to the opening balance of retained earnings totaling $12,263. There was no cumulative effect for performance and incentive fees or fund expense reimbursement accounting. The comparative information for prior periods has not been restated and continues to be reported under the prior accounting guidance in effect for those periods. A summary of the cumulative-effect changes to Legg Mason’s Consolidated Balance Sheet as of April 1, 2018 is included below.
Legg Mason primarily earns revenues by providing investment management services and distribution and shareholder services for its customers, which are generally investment funds or the underlying investors in separately managed accounts. As further discussed below, revenues are calculated based on the value of the investments under management and are recognized when obligations under the terms of contracts with customers are satisfied, which is generally over time as the services are rendered.


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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. Generally, investment management services are a single performance obligation, as they include a series of distinct services that are substantially the same and are transferred to the customer over time using the same time-based measure of progress. Investment management services are satisfied over time as the customer simultaneously receives and consumes the benefits as the advisory services are performed.

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.

Separate Account and Funds Advisory Fees
Separate account and funds advisory fees are variable consideration which is primarily based on predetermined percentages of the daily, monthly or quarterly average market value of the assets under management ("AUM"), as defined in the investment management agreements. The average market value of AUM is subject to change based on fluctuations and volatility in financial markets, and as such, separate account and funds advisory fees are constrained until the end of the month or quarter when the actual average market value of the AUM is known and a significant revenue reversal is no longer probable. Therefore, separate account and funds advisory fees are included in the transaction price and allocated to the investment management services performance obligation at the end of each monthly or quarterly reporting period, as specified in the investment management contract. Payment for services under investment management contracts is due once the variable consideration is allocated to the transaction price, and generally within 30 days. Recognition of separate account and funds advisory fee revenue under the updated guidance is consistent with Legg Mason’s prior revenue recognition process.

Performance and Incentive Fees
Performance and incentive fees are variable consideration that may be earned on certain investment management contracts for exceeding performance benchmarks on a relative or absolute basis or for exceeding contractual return thresholds. Performance and incentive fees are estimated at the inception of a contract; however, a range of outcomes is possible due to factors outside the control of the investment manager, particularly market conditions. Performance and incentive fees are therefore excluded from the transaction price until it becomes probable that a significant reversal in the cumulative amount of revenue recognized will not occur. A portion of Legg Mason's performance and incentive 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 also earns performance and incentive fees on alternative and certain other products that lock at the earlier of the investor’s termination date or the liquidation of the fund or contract, in multiple-year intervals, or upon the occurrence of specific events, such as the sale of assets. For certain of these products, performance and incentive fees may be recognized as revenue earlier under the updated guidance than under prior revenue recognition practices, which deferred recognition until all contingencies were resolved. Any such performance fees recognized prior to the resolution of all contingencies are recorded as a contract asset in Other current assets or Other non-current assets in the Consolidated Balance Sheet.

Fee Waivers and Fund Expense Reimbursements
Legg Mason may waive certain fees for investors or may reimburse its investment funds for certain operating expenses when such expenses exceed a certain threshold. Fee waivers continue to be reported as a reduction in advisory fee revenue under the updated guidance. Under prior accounting guidance, fund expense reimbursements in excess of recognized revenue were recorded as Other expense in the Consolidated Statements of Income. Under the updated accounting guidance, these fund expense reimbursements that exceed the recognized revenue represent a change in the transaction price and are therefore reported as a reduction of Investment advisory fees - Funds in the Consolidated Statements of Income.

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 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, and non-discretionary advisory services for assets under advisement. Distribution and service fees earned on company-sponsored investment funds are reported as revenue. Distribution services and marketing services are considered a single performance obligation as the success of selling the underlying shares is highly dependent upon the sales and marketing efforts. Ongoing shareholder servicing is a separate performance obligation as these services are not highly interrelated and interdependent on the sale of the shares. Fees earned related to distribution and shareholder serving are considered variable consideration because they are calculated based on the average market value of the fund. The average market value of the fund is subject

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to change based on fluctuations and volatility in financial markets, and as such, distribution and shareholder service fees are generally constrained until the end of the month or quarter when the actual market value of the fund is known and the related revenue is no longer subject to a significant reversal. Therefore, distribution and service fees are generally included in the transaction price at the end of each monthly or quarterly reporting period and are allocated to the two performance obligations based on the amount specified in each agreement. While distribution services are largely satisfied at the inception of an investment, the ultimate amounts of revenue are subject to the variable consideration constraint. Accordingly, a portion of distribution and service revenue will be recognized in periods subsequent to the satisfaction of the performance obligation.

Certain fund share classes only charge for distribution services at the inception of the investment based on a fixed percentage of the share price. This fixed price is allocated to the performance obligation, which is substantially satisfied at the time of the initial investment.

Recognition of distribution and service fee revenue under the updated guidance is consistent with Legg Mason’s prior revenue recognition process.

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 and is recorded as Distribution and servicing expense in the Consolidated Statements of Income. Distribution and servicing expense also includes payments to third parties for certain shareholder administrative services and sub-advisory fees paid to unaffiliated asset managers.

Contract Costs and Deferred Sales Commissions
Legg Mason incurs ordinary costs to obtain investment management contracts and for services provided to customers in accordance with investment management agreements. These costs include commissions paid to wholesalers, employees and third-party broker dealers and administration and placement fees. Depending on the type of services provided, these fees may be paid at the time the contract is obtained or on an ongoing basis. Under the updated guidance, costs to obtain a contract should be capitalized if the costs are incremental and would not have been incurred if the contract had not been obtained, and costs to fulfill the contract should be capitalized if they relate directly to a contract, the costs will generate or enhance resources of the entity that will be used in satisfying performance obligations in the future, and the costs are expected to be recovered. Consistent with prior accounting procedures, fund launch costs, including organizational and underwriting costs, placement fees and commissions paid to employees, wholesalers and broker-dealers for sales of fund shares are expensed as incurred, as these costs would be incurred regardless of the investor. However, commissions paid to employees and retail wholesalers in connection with the sale of retail separate accounts are considered incremental, as these fees relate to obtaining a specific contract, are calculated based on specified rates and are recoverable through the management fees earned, and are therefore capitalized under the updated accounting guidance. Such commissions were expensed as incurred under Legg Mason’s prior accounting practices. Capitalized sales commissions are amortized based on the transfer of services to which the assets relate, which averages four years. Legg Mason recorded a cumulative-effect adjustment on the Consolidated Balance Sheet as of April 1, 2018, as an increase to Retained earnings of $14,839, an increase to Other current assets of $9,615, an increase to Other non-current assets of $10,316, a decrease to Deferred income tax assets of $1,148 and an increase to Deferred income tax liabilities of $3,944 to reflect the capitalization of these commissions.

Commissions paid by Legg Mason to financial intermediaries in connection with sales of certain classes of company-sponsored mutual funds are generally 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 consideration is generally variable and is based on the timing of when investors redeem their investment. Therefore, the variable consideration is included in the transaction price once the investors redeem their shares and is satisfied at a point in time. 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 three months ended June 30,

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2018 and 2017, no impairment charges were recorded. Deferred sales commissions, included in Other non-current assets in the Consolidated Balance Sheets, were $1,625 and $4,047 at June 30, 2018 and March 31, 2018, respectively.

Under the updated accounting guidance, Legg Mason has elected to expense sales commissions related to certain share classes with amortization periods of one year or less as incurred. Legg Mason recorded a cumulative-effect adjustment of $2,576 on the Consolidated Balance Sheet as of April 1, 2018, as a reduction to Other non-current assets, with a corresponding reduction in Retained earnings to reflect the expense associated with such commissions, which had previously been capitalized under Legg Mason's prior accounting practices.

Impact of the Adoption of Updated Revenue Recognition Accounting Guidance
The cumulative effect of the changes made to Legg Mason’s Consolidated Balance Sheet as of April 1, 2018 for the adoption of the updated revenue recognition accounting guidance were as follows:
Consolidated Balance Sheet
 
Balance as of March 31, 2018
 
Adjustment due to Adoption of Updated Accounting Guidance
 
Balance as of April 1, 2018
Assets
 
 
 
 
 
 
Other, current
 
$
65,010

 
$
9,615

 
$
74,625

Deferred income taxes
 
202,068

 
(1,148
)
 
200,920

Other, non-current
 
134,407

 
7,740

 
142,147

Liabilities
 
 
 
 
 
 
Deferred income taxes
 
$
139,787

 
$
3,944

 
$
143,731

Stockholders' Equity
 
 
 
 
 
 
Retained Earnings
 
$
1,894,762

 
$
12,263

 
$
1,907,025


The impact of the adoption of the updated revenue recognition accounting guidance on the Consolidated Balance Sheet and the Consolidated Statement of Income was as follows:
 
 
June 30, 2018
Consolidated Balance Sheet
 
Balances Excluding the Adoption of Updated Accounting Guidance
 
Impact of the Adoption of Updated Accounting Guidance
 
As Reported
Assets
 
 
 
 
 
 
Other, current
 
$
66,781

 
$
8,177

 
$
74,958

Deferred income taxes
 
200,579

 
(1,148
)
 
199,431

Other, non-current
 
135,892

 
9,171

 
145,063

Liabilities
 
 
 
 
 
 
Deferred income taxes
 
$
152,046

 
$
3,944

 
$
155,990

Stockholders Equity
 
 
 
 
 
 
Retained Earnings
 
$
1,929,732

 
$
12,256

 
$
1,941,988



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For three months ended June 30, 2018
Consolidated Statement of Income
 
Balances Excluding the Adoption of Updated Accounting Guidance
 
Impact of the Adoption of Updated Accounting Guidance
 
As Reported
Operating Revenues
 
 
 
 
 
 
Investment advisory fees:
 
 
 
 
 
 
Funds
 
$
384,847

 
$
(1,283
)
 
$
383,564

Operating Expenses
 
 
 
 
 
 
Compensation and benefits
 
$
361,214

 
$
354

 
$
361,568

Distribution and servicing
 
116,939

 
(347
)
 
116,592

Other
 
57,102

 
(1,283
)
 
55,819


Cash Flow Reporting    
Effective April 1, 2018, Legg Mason adopted updated accounting guidance on a retrospective basis which clarifies the classification and presentation of restricted cash, investment activity and other items in the statements of cash flows. The updated guidance requires entities to include restricted cash and restricted cash equivalents in the cash and cash equivalents balances on the consolidated statements of cash flows and to disclose a reconciliation between the balances on the consolidated statements of cash flows and the consolidated balance sheets. Legg Mason includes cash of consolidated investment vehicles in restricted cash. Legg Mason’s restricted cash balances at June 30, 2018 and 2017, were $26,614 and $19,918, respectively. The updated guidance also clarifies how distributions from equity method investees should be classified based on either the cumulative earnings or the nature of distribution approach. Legg Mason elected to apply the nature of distribution approach when classifying distributions received from equity method investees. As a result of adopting this aspect of the updated guidance, $1,932 was reclassified from Cash Used In Operating Activities to Cash Used in Investing Activities in the Consolidated Statement of Cash Flows for the three months ended June 30, 2017.

Financial Instruments
Effective April 1, 2018, Legg Mason adopted accounting guidance on a prospective basis which requires equity investments to be measured at fair value, with changes recognized in earnings. This guidance does not apply to investments accounted for under the equity method of accounting or underlying investments of consolidated entities. The updated guidance also provides entities the option to elect to measure equity investments that do not have readily determinable fair values and do not qualify for the net asset value ("NAV") practical expedient at "adjusted cost". Under this adjusted cost method, investments are initially recorded at cost, and subsequently adjusted (increased or decreased) when there is an observable transaction involving the same investment, or similar investment from the same issuer. Adjusted cost investment carrying values are also adjusted for impairments, if any. Legg Mason has elected to measure certain investments under the adjusted cost approach. The adoption of this updated guidance did not have a material impact on Legg Mason’s consolidated financial statements.


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Table of Contents

Recent Accounting Developments
In June 2018, the Financial Accounting Standards Board ("FASB") ratified an Emerging Issues Task Force consensus that updates the guidance for accounting for implementation costs incurred for a cloud computing arrangement that is a service contract. The update conforms the requirements for capitalizing implementation costs incurred in a cloud computing arrangement that is a service contract with the accounting guidance that provides for capitalization of costs incurred to develop or obtain internal-use-software. Legg Mason will begin to evaluate the impact of its adoption upon issuance of the final guidance.

In August 2017, the FASB updated the guidance on accounting for derivative hedging. The updated guidance more closely aligns the results of cash flow and fair value hedging designations with risk management activities through changes to both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results in the financial statements.  The new guidance also simplifies the application of hedge accounting.  The updated guidance is effective for Legg Mason in fiscal 2020, unless adopted earlier.  Legg Mason uses accounting hedge designation from time-to-time and would only potentially be impacted if derivative transactions were designated for hedging.

In January 2017, the FASB updated the guidance to simplify the test for goodwill impairment. The updated guidance still requires entities to perform annual goodwill impairment tests by comparing the fair value of a reporting unit with its related carrying amount, but it eliminates the requirement to potentially calculate the implied fair value of goodwill to determine the amount of impairment, if any. Under the new guidance, an entity should recognize an impairment charge if the reporting unit's carrying amount exceeds the reporting unit’s fair value, in the amount of such excess.  The guidance will be effective in fiscal 2020. Legg Mason is evaluating its adoption.

In February 2016, the FASB updated the guidance on accounting for leases. The updated guidance requires that a lessee shall recognize the assets and liabilities that arise from lease transactions. A lessee will recognize a right-of-use asset to use the underlying asset and a liability representing the lease payments. The updated guidance also requires an evaluation at the inception of a service or other contract, to determine whether the contract is or contains a lease. In July 2018, the FASB further updated the lease guidance to make certain targeted improvements related to transition method at adoption and separating components of a contract. The update allows for the guidance to be adopted on a modified retrospective basis and provides a practical expedient to not separate non-lease components from the associated lease components and instead, account for those components as a combined lease. The guidance will be effective for Legg Mason in fiscal 2020. Legg Mason expects to recognize right of use assets and liabilities upon its adoption of the new standard and is continuing to evaluate the full impact of adoption, including transition method and practical expedient election.

  

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Table of Contents

3. Investments and Fair Value of Assets and Liabilities

The disclosures below include details of Legg Mason's financial assets and financial liabilities that are measured at fair value and NAV, excluding the financial assets and financial liabilities of CIVs. See Note 14, Variable Interest Entities and Consolidation of Investment Vehicles, for information related to the assets and liabilities of CIVs that are measured at fair value.

The fair values of financial assets and (liabilities) of the Company were determined using the following categories of inputs:
 
 
As of June 30, 2018
 
 
Quoted prices in active markets
(Level 1)
 
Significant other observable inputs
(Level 2)
 
Significant unobservable inputs
(Level 3)
 
Investments measured at NAV
 
Total
Assets:
 
 
 
 
 
 
 
 
 
 
Cash equivalents:(1)
 
 
 
 
 
 
 
 
 
 
Money market funds
 
$
281,083

 
$

 
$

 
$

 
$
281,083

Time deposits and other
 

 
9,928

 

 

 
9,928

Total cash equivalents
 
281,083


9,928

 

 

 
291,011

Investments of proprietary fund products and other investments:(2)
 
 
 
 
 
 
 
 
 
 

Seed capital investments
 
118,029

 
30,601

 
1,390

 
1,212

 
151,232

Other(3)
 
18,748

 
2,083

 

 

 
20,831

Investments relating to long-term incentive compensation plans(4)
 
208,812

 

 

 

 
208,812

Equity method investments relating to long-term incentive compensation plans(5)
 

 

 

 
11,421

 
11,421

Total current investments(6)
 
345,589


32,684

 
1,390

 
12,633

 
392,296

Equity method investments in partnerships and LLCs:(5)(7)
 
 
 
 
 
 
 
 
 
 
Seed capital investments(6)
 

 

 
1,052

 
13,340

 
14,392

Seed capital investments in real estate funds
 

 

 
32,930

 

 
32,930

Other
 

 

 
1,150

 
11,441

 
12,591

Adjusted cost investments:
 
 
 
 
 
 
 
 
 
 
Investments related to long-term incentive compensation plans
 

 

 
6,458

 

 
6,458

Other
 

 
75

 
4,492

 

 
4,567

Derivative assets(8)
 
7,296

 

 

 

 
7,296

Total
 
$
633,968


$
42,687

 
$
47,472

 
$
37,414

 
$
761,541

Liabilities:
 
 
 
 
 
 
 
 
 
 
Contingent consideration liabilities(9)
 
$

 
$

 
$
(6,074
)
 
$

 
$
(6,074
)
Derivative liabilities(8)
 
(3,512
)
 

 

 

 
(3,512
)
Total
 
$
(3,512
)
 
$

 
$
(6,074
)
 
$

 
$
(9,586
)

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Table of Contents

 
 
As of March 31, 2018
 
 
Quoted prices in active markets
(Level 1)
 
Significant other observable inputs
(Level 2)
 
Significant unobservable inputs
(Level 3)
 
Investments measured at NAV
 
Total
Assets:
 
 
 
 
 
 
 
 
 
 
Cash equivalents:(1)
 
 
 
 
 
 
 
 
 
 
Money market funds
 
$
350,142

 
$

 
$

 
$

 
$
350,142

Time deposits and other
 

 
13,863

 

 

 
13,863

Total cash equivalents
 
350,142

 
13,863

 

 

 
364,005

Trading investments of proprietary fund products and other trading investments:(2)
 
 
 
 
 
 
 
 
 
 
Seed capital investments
 
131,715

 
37,598

 
1,242

 
3,225

 
173,780

Other(3)
 
29,051

 
2,565

 

 

 
31,616

Trading investments relating to long-term incentive compensation plans(4)
 
184,639

 

 

 
99

 
184,738

Equity method investments relating to proprietary fund products and long-term incentive compensation plans:(5)
 

 

 

 
9,236

 
9,236

Total current investments(6)
 
345,405


40,163

 
1,242

 
12,560

 
399,370

Equity method investments in partnerships and LLCs:(5)(7)
 
 
 
 
 
 
 
 
 
 
Seed capital investments(6)
 

 

 
962

 
14,360

 
15,322

Seed capital investments in real estate funds
 

 

 
32,763

 

 
32,763

Other
 

 

 

 
11,915

 
11,915

Investments in partnerships and LLCs:(7)
 
 
 
 
 
 
 
 
 
 
Seed capital investments
 

 

 

 
2,549

 
2,549

Investments related to long-term incentive compensation plans
 

 

 
6,458

 

 
6,458

Other
 

 
78

 
380

 

 
458

Derivative assets(8)
 
4,904

 

 

 

 
4,904

Other investments(7)
 

 

 
113

 

 
113

Total
 
$
700,451

 
$
54,104

 
$
41,918

 
$
41,384

 
$
837,857

Liabilities:
 
 
 
 
 
 
 
 
 
 
Contingent consideration liabilities(9)
 
$

 
$

 
$
(5,607
)
 
$

 
$
(5,607
)
Derivative liabilities(8)
 
(6,446
)
 

 

 

 
(6,446
)
Total
 
$
(6,446
)
 
$

 
$
(5,607
)
 
$

 
$
(12,053
)
(1)
Cash equivalents include highly liquid investments with original maturities of 90 days or less. Cash investments in actively traded money market funds 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 purchase of the instrument and its expected realization and are classified as Level 2.
(2)
Current investments of proprietary fund products and other current investments consist of approximately 84% and 16% equity and debt securities, respectively, as of June 30, 2018, and approximately 81% and 19% equity and debt securities, respectively, as of March 31, 2018.
(3)
Includes $8,978 and $15,452 in noncontrolling interests associated with consolidated seed investment products as of June 30, 2018 and March 31, 2018, respectively.
(4)
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.
(5)
Certain of Legg Mason's equity method investments are investment companies that record underlying investments at fair value. Therefore, the fair value of these investments 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. Other equity method investments not measured at fair value on a recurring basis are excluded from the tables above.
(6)
Excludes $42,594 and $43,854 of seed capital as of June 30, 2018 and March 31, 2018, respectively, which is related to Legg Mason's investments in CIVs. See Note 14.
(7)
Amounts are included in Other non-current assets in the Consolidated Balance Sheets for each of the periods presented.
(8)
See Note 13.
(9)
See Note 7.


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Table of Contents

Proprietary fund products include seed capital investments made by Legg Mason to fund new investment strategies and products. Legg Mason had seed capital investments in proprietary fund products, which totaled $241,148 and $268,268 as of June 30, 2018 and March 31, 2018, respectively, which are substantially comprised of investments in 57 funds and 59 funds, respectively, that are individually greater than $1,000, and together comprise over 90% of the total seed capital investments at each period end.

As further discussed in Notes 2, 13, and 14, Legg Mason has entered into various total return swap arrangements with financial intermediaries with respect to two Legg Mason sponsored ETFs for aggregate notional amounts totaling $38,327 as of June 30, 2018, which resulted in the investment in the two ETFs by these financial intermediaries. Under the terms of the total return swap arrangements, Legg Mason receives all the investment gains and losses on the underlying investments and therefore is required to consolidate each of the sponsored investment funds, which were designated as CIVs.

See Notes 2 and 14 for information regarding the determination of whether investments in proprietary fund products represent VIEs and consolidation.
The net realized and unrealized gain (loss) for investment securities classified as trading was $477 and $10,169 for the three months ended June 30, 2018 and 2017, respectively.
The net unrealized gains (losses) relating to trading investments still held as of the reporting dates were $(16,877) and $2,068 for the three months ended June 30, 2018 and 2017, respectively.

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Table of Contents

The changes in financial assets and (liabilities) measured at fair value using significant unobservable inputs (Level 3) for the three months ended June 30, 2018 and 2017, are presented in the tables below:
 
 
Balance as of March 31, 2018
 
Purchases
 
Sales
 
Redemptions/ Settlements/ Other
 
Transfers
 
Realized and unrealized gains/(losses), net
 
Balance as of June 30, 2018
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Investments of seed capital investments in proprietary fund products
 
$
1,242

 
$

 
$

 
$

 
$

 
$
148

 
$
1,390

Equity method investments in partnerships and LLCs:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Seed capital investments
 
962

 

 

 

 

 
90
 
1,052

Seed capital investments in real estate funds
 
32,763

 
47

 

 
(228
)
 

 
348

 
32,930

Other
 

 
1,150

 

 

 

 

 
1,150

Adjusted cost investments:
 
 
 
 
 
 
 
 
 
 
 
 
 


Investments related to long-term incentive compensation plans
 
6,458

 

 

 

 

 

 
6,458

Other
 
493

 
4,000

 

 
(2
)
 

 
1

 
4,492

 
 
$
41,918

 
5,197

 

 
(230
)
 

 
587

 
$
47,472

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Contingent consideration liabilities
 
$
(5,607
)
 
n/a

 
n/a

 
n/a

 
n/a

 
$
(467
)
 
$
(6,074
)
n/a - not applicable


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Table of Contents

 
 
Balance as of March 31, 2017
 
Purchases
 
Sales
 
Redemptions/ Settlements/ Other
 
Transfers
 
Realized and unrealized gains/(losses), net
 
Balance as of June 30,
 2017
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Equity method investments relating to long-term incentive compensation plans
 
$
1,337

 
$
11

 
$

 
$
(11
)
 
$

 
$
12

 
$
1,349

Equity method investments in partnerships and LLCs:
 


 


 


 


 


 


 


Seed capital investments
 
752

 

 

 

 

 
61

 
813

Seed capital investments in real estate funds
 
26,909

 
439

 

 
(619
)
 

 
453

 
27,182

Other proprietary fund products
 
1,646

 

 

 

 

 

 
1,646

Investments in partnerships and LLCs:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Investments related to long-term incentive compensation plans
 
9,315

 
52

 

 

 

 

 
9,367

Other proprietary fund products
 
1,825

 

 

 
(7
)
 

 

 
1,818

Other investments
 
113

 

 

 

 

 
(1
)
 
112

 
 
$
41,897

 
$
502

 
$

 
$
(637
)
 
$

 
$
525

 
$
42,287

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Contingent consideration liabilities
 
$
(36,810
)
 
n/a

 
n/a

 
n/a

 
n/a

 
$
16,113

 
$
(20,697
)
n/a - not applicable

Realized and unrealized gains and losses recorded for Level 3 investments are primarily included in Other non-operating income (expense), net, in the Consolidated Statements of Income. The change in unrealized gains (losses) for Level 3 investments and liabilities still held at the reporting date was $117 and $16,638 for the three months ended June 30, 2018 and 2017, respectively.

There were no significant transfers between Level 1 and Level 2 during the three months ended June 30, 2018 and 2017.


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Table of Contents

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 June 30, 2018 and March 31, 2018, the nature of these investments and any related liquidation restrictions or other factors which may impact the ultimate value realized:
 
 
 
 
Fair Value Determined Using NAV
 
As of June 30, 2018
Category of Investment
 
Investment Strategy
 
June 30, 2018
 
March 31, 2018
 
Unfunded Commitments
 
Remaining Term
Funds-of-hedge funds
 
Global macro, fixed income, long/short equity, natural resources, systematic, emerging market, European hedge
 
$
10,331

(1)
$
11,122

 
n/a

 
n/a
Hedge funds
 
Fixed income - developed market, event driven, fixed income - hedge, relative value arbitrage, European hedge
 
2,118

 
6,479

 
$
20,000

 
n/a
Private equity funds
 
Long/short equity
 
13,417

(2)
14,377

 
6,313

 
Up to 11 years
Equity method
 
Alternatives, structured securities, short-dated fixed income
 
11,421

(2)
9,236

 
n/a

 
n/a
Other
 
Various
 
127

 
170

 
n/a

 
Various (3)
Total
 
 
 
$
37,414

 
$
41,384

 
$
26,313

 
 
n/a - not applicable
(1)
Liquidation restrictions: 21% monthly redemption, 6% quarterly redemption, and 73% are not subject to redemption or are not currently redeemable.
(2)
Liquidations are expected over the remaining term.
(3)
Of this balance, 35% has a remaining term of less than one year and 65% has a remaining term of 14 years.

There are no current plans to sell any of these investments held as of June 30, 2018.

4. Fixed Assets

Fixed assets primarily consist of equipment, software and leasehold improvements. Equipment consists primarily of communications and technology hardware and furniture and fixtures. Capitalized software includes both purchased software and internally developed software. Fixed assets are reported at cost, net of accumulated depreciation and amortization. The following table reflects the components of fixed assets as of:
 
 
June 30, 2018
 
March 31, 2018
Equipment
 
$
156,200

 
$
172,308

Software
 
258,460

 
323,088

Leasehold improvements
 
222,976

 
209,810

Total cost
 
637,636

 
705,206

Less: accumulated depreciation and amortization
 
(483,321
)
 
(556,800
)
Fixed assets, net
 
$
154,315

 
$
148,406


Depreciation and amortization expense related to fixed assets was $11,367 and $12,134 for the three months ended June 30, 2018, and 2017, and respectively.



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5. Intangible Assets and Goodwill

The following table reflects the components of intangible assets as of:
 
 
June 30, 2018
 
March 31, 2018
Amortizable intangible asset management contracts and other
 
 

 
 

Cost
 
$
374,516

 
$
376,996

Accumulated amortization
 
(222,762
)
 
(218,076
)
Net
 
151,754

 
158,920

Indefinite–life intangible assets
 


 
 
U.S. domestic mutual fund management contracts
 
2,106,351

 
2,106,351

Clarion Partners fund management contracts
 
505,200

 
505,200

EnTrustPermal fund management contracts
 
401,404

 
401,404

Other fund management contracts
 
544,611

 
557,305

Trade names
 
67,995

 
68,479

 
 
3,625,561

 
3,638,739

Intangible assets, net
 
$
3,777,315

 
$
3,797,659


Certain of Legg Mason's intangible assets are denominated in currencies other than the U.S. dollar and balances related to these assets will fluctuate with changes in the related foreign currency exchange rates.

Indefinite-life Intangible Assets and Goodwill
In Legg Mason's annual impairment test as of December 31, 2017, the assessed fair value of the EnTrustPermal indefinite-life fund management contracts intangible asset declined below its carrying value, and accordingly was impaired during the year ended March 31, 2018. Should market performance and/or AUM levels of EnTrustPermal decrease in the near term such that cash flow projections deviate from current projections, it is reasonably possible that the assets could become impaired, and the impairment could be a material amount.

As of December 31, 2017, the assessed fair value of the RARE Infrastructure indefinite-life fund management contracts intangible asset exceeded the carrying value of $132,780 (using the exchange rate as of December 31, 2017) by approximately 3% and the assessed fair value of the RARE Infrastructure trade name indefinite-life intangible asset exceeded the carrying value of $3,054 (using the exchange rate as of December 31, 2017) by approximately 19%. Should market performance and/or the related AUM levels decrease in the near term such that cash flow projections deviate from current projections, it is reasonably possible that either of these assets could become impaired, and the impairment could be a material amount.

Legg Mason determined that no triggering events occurred as of June 30, 2018 that would require further impairment testing.

As a result of AUM losses and other factors during the three months ended June 30, 2017, Legg Mason tested the RARE Infrastructure trade name indefinite-life intangible asset for impairment during the three months ended June 30, 2017. The carrying value of the trade name exceeded its fair value of $3,057 as of June 30, 2017, which resulted in an impairment charge of $2,000. Management estimated the fair value of the RARE Infrastructure trade name as of June 30, 2017 based upon a relief from royalty approach and a discounted cash flow method using unobservable market data inputs, which are Level 3 measurements. The significant assumptions used in the cash flow analysis included projected annual revenue growth rates of 5% to 18% (average: 8%), a royalty rate of 1.0%, and a discount rate of 16.5%.



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The change in carrying value of goodwill is summarized below:
 
 
Gross Book Value
 
Accumulated Impairment
 
Net Book Value
Balance as of March 31, 2018
 
$
3,094,255

 
$
(1,161,900
)
 
$
1,932,355

Impact of excess tax basis amortization
 
(2,755
)
 

 
(2,755
)
Changes in foreign exchange rates and other
 
(27,674
)
 

 
(27,674
)
Balance as of June 30, 2018
 
$
3,063,826

 
$
(1,161,900
)
 
$
1,901,926


Amortizable Intangible Asset Management Contracts and Other
There were no impairments to amortizable asset management contract intangible assets during the three months ended June 30, 2018.

As of June 30, 2018, amortizable intangible asset management contracts and other are being amortized over a weighted-average remaining life of 6.7 years.

Estimated amortization expense for each of the next five fiscal years and thereafter is as follows:
Remaining fiscal 2019
 
$
18,647

2020
 
24,085

2021
 
23,254

2022
 
22,905

2023
 
20,198

Thereafter
 
42,665

Total
 
$
151,754


During the three months ended June 30, 2017, projected revenues related to the RARE Infrastructure separate account contacts amortizable asset declined due to losses of separate account AUM and other factors, including the withdrawal of approximately $1,500,000 by an institutional client in June 2017. Based on revised attrition estimates, the remaining useful life of the acquired contracts was decreased from eight years to five years at June 30, 2017. As a result of the decline in projected revenues and the revised estimate of the remaining useful life, the amortized carrying value was determined to exceed its fair value and an impairment charge of $32,000 was recorded during the three months ended June 30, 2017. Management estimated the fair value of this asset based upon a discounted cash flow analysis using unobservable market inputs, which are Level 3 measurements. The significant assumptions used in the cash flow analysis included projected AUM growth rates of 7%, attrition rates of 20%, and a discount rate of 16.5%.

6. Short-Term Borrowings and Long-Term Debt

Short-term borrowings
On December 29, 2015, Legg Mason entered into an unsecured credit agreement (as amended from time to time, the "Credit Agreement") which provided for a $1,000,000 multi-currency revolving credit facility. The Credit Agreement was amended on March 31, 2017 to reduce the amount available for borrowing from $1,000,000 to $500,000. The revolving credit facility may be increased by an aggregate amount of up to $500,000, subject to the approval of the lenders, expires in December 2020, and can be repaid at any time. This revolving credit facility is available to fund working capital needs and for general corporate purposes.

As of both June 30, 2018 and March 31, 2018, Legg Mason had $125,500 of borrowings outstanding under the Credit Agreement. The effective interest rate on the outstanding borrowings was 3.56% and 2.95% as of June 30, 2018 and March 31, 2018, respectively.



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Long-term debt
Long-term debt, net, consists of the following:
 
 
June 30, 2018
 
March 31, 2018
 
 
Carrying Value
 
Fair Value Hedge Adjustment
 
Unamortized Discount (Premium)
 
Unamortized Debt Issuance Costs
 
Maturity Amount
 
Carrying Value
2.7% Senior Notes due
July 2019
 
$
251,306

 
$
(1,804
)
 
$
113

 
$
385

 
$
250,000

 
$
251,641

3.95% Senior Notes due
July 2024
 
248,561

 

 
275

 
1,164

 
250,000

 
248,502

4.75% Senior Notes due March 2026
 
447,255

 

 

 
2,745

 
450,000

 
447,166

5.625% Senior Notes due January 2044
 
547,960

 

 
(3,121
)
 
5,161

 
550,000

 
547,940

6.375% Junior Notes due March 2056
 
242,309

 

 

 
7,691

 
250,000

 
242,258

5.45% Junior Notes due September 2056
 
484,405

 

 

 
15,595

 
500,000

 
484,303

Total
 
$
2,221,796

 
$
(1,804
)
 
$
(2,733
)
 
$
32,741

 
$
2,250,000

 
$
2,221,810


As of June 30, 2018, $250,000 of Legg Mason's long-term debt matures in fiscal 2020, and $2,000,000 matures after fiscal 2023.

As of June 30, 2018, the estimated fair value of Long-term debt was $2,295,249. The fair value of debt was estimated using publicly quoted market prices and was classified as Level 2 in the fair value hierarchy.

7. 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 2038. Certain leases provide for renewal options and contain escalation clauses providing for increased rentals based upon maintenance, utility and tax increases.

As of June 30, 2018, the minimum annual aggregate rentals under operating leases and service agreements are as follows:
Remaining fiscal 2019
 
$
106,793

2020
 
124,041

2021
 
106,324

2022
 
96,180

2023
 
86,850

Thereafter
 
120,596

Total(1)
 
$
640,784

(1) Includes $544,718 in real estate and equipment leases and $96,066 in service and maintenance agreements.
 
The minimum rental commitments shown above have not been reduced by $107,534 for minimum sublease rentals to be received in the future under non-cancelable subleases, of which approximately 35% is due from one counterparty.  The lease reserve liability, which is included in the table below, for space subleased as of June 30, 2018 and March 31, 2018, was $22,632 and $24,188, respectively. 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, dependent on the commercial real estate market at such time.

The minimum rental commitments shown above also include $8,263 for commitments related to space that has been vacated, but for which subleases are being pursued. The related lease reserve liability, also included in the table below, was $4,590

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and $5,061 as of June 30, 2018 and March 31, 2018, respectively, 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 lease reserve liability for subleased space and vacated space for which subleases are being pursued is included in Other current liabilities and Other non-current liabilities in the Consolidated Balance Sheets. The table below presents a summary of the changes in the lease reserve liability:
Balance as of March 31, 2017
 
$
39,688

Payments, net
 
(13,019
)
Adjustments and other
 
2,580

Balance as of March 31, 2018
 
29,249

Payments, net
 
(2,182
)
Adjustments and other
 
155

Balance as of June 30, 2018
 
$
27,222


As of June 30, 2018, Legg Mason had commitments to invest $44,282 in limited partnerships that make private investments. These commitments are expected to be outstanding, or funded as required, through the end of their respective investment periods ranging through fiscal 2030. Also, in connection with the acquisition of Clarion Partners in April 2016, Legg Mason committed to provide $100,000 of seed capital to Clarion Partners products. Legg Mason also committed to contribute up to $5,000 of additional working capital to Financial Guard, to be paid over the two-year period following the acquisition, the final $2,500 of which was paid during the three months ended June 30, 2018.

As of June 30, 2018, Legg Mason had various commitments to pay contingent consideration relating to business acquisitions. The following table presents a summary of the maximum remaining contingent consideration and changes in the contingent consideration liability for certain of Legg Mason's acquisitions.
 
 
RARE Infrastructure
 
Martin Currie
 
QS Investors
 
Other(2)
 
Total
Acquisition Date
 
October 21, 2015
 
October 1, 2014
 
May 30, 2014
 
Various
 
 
Maximum Remaining Contingent Consideration(1)
 
$
78,366

 
$

 
$
23,400

 
$
1,900

 
$
103,666

Contingent Consideration Liability
 
 
 
 
 
 
 
 
 
 
Balance as of March 31, 2017
 
$
17,444

 
$
12,018

 
$
4,841