Notes to Consolidated Financial Statements
Note 1
Business and Organization
Diamond Hill Investment Group, Inc. (the “Company”), an Ohio corporation, derives its consolidated revenues and net income from investment advisory and fund administration services.
Diamond Hill Capital Management, Inc. (“DHCM”), an Ohio corporation, is a wholly owned subsidiary of the Company and a registered investment adviser. DHCM is the investment adviser to the Diamond Hill Funds (the “Funds”), a series of open-end mutual funds, private investment funds (“Private Funds”), an exchange traded fund (the “ETF”), and other institutional accounts. In addition, DHCM is administrator for the Funds.
Beacon Hill Fund Services, Inc. (“BHFS”) and BHIL Distributors, Inc. (“BHIL”), collectively operated as “Beacon Hill,” were former operating subsidiaries of the Company. The Company sold Beacon Hill on July 31, 2016. Prior to the sale, Beacon Hill provided compliance, treasury, underwriting and other fund administration services to investment advisers and mutual funds. See
Note 11
for additional information regarding the sale of Beacon Hill.
Note 2
Significant Accounting Policies
Basis of Presentation
The accompanying Consolidated Financial Statements of the Company have been prepared pursuant to the rules and regulations of the U. S. Securities and Exchange Commission (“SEC”) and in accordance with the instructions to Form 10-K. The Company believes that the disclosures contained herein are adequate to make the information presented not misleading.
These Consolidated Financial Statements reflect, in the opinion of the Company, all material adjustments (which include only normal recurring adjustments) necessary to fairly present the Company’s financial position as of
December 31, 2018
and
2017
, and results of operations for the years ended
December 31, 2018
,
2017
and
2016
. The preparation of the Consolidated Financial Statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported amounts of revenue and expense during the reporting period. Estimates have been prepared on the basis of the most current and best available information, but actual results could differ materially from those estimates.
Book value per share is computed by dividing total shareholders’ equity by the number of shares issued and outstanding at the end of the measurement period.
Reclassification
Certain prior period amounts and disclosures may have been reclassified to conform to the current period’s financial presentation.
Principles of Consolidation
The accompanying consolidated financial statements include the operations of the Company and its controlled subsidiaries. All inter-company transactions and balances have been eliminated in consolidation.
The Company holds certain investments in the Funds and the ETF for general corporate investment purposes, to provide seed capital for newly formed strategies or to add capital to existing strategies. The Funds are organized in a series fund structure in which there are multiple mutual funds within one Trust. The Trust is an open-end investment company registered under the Investment Company Act of 1940, as amended (the”1940 Act”). The ETF is an individual series of ETF Series Solutions which is also an open-end investment company registered under the 1940 Act. Each of the individual mutual funds and the ETF represents a separate share class of a legal entity organized under the Trust.
As of January 1, 2016, the Company adopted ASU 2015-02 - Consolidation (Topic 810): Amendments to the Consolidation Analysis (“ASU 2015-02”) and we have performed our consolidation analysis at the individual mutual fund and ETF level and have concluded the mutual funds and ETF are voting rights entities (“VREs”) because the structure of the investment product is such that the shareholders are deemed to have the power through voting rights to direct the activities that most significantly impact the entity’s economic performance. To the extent material, these investment products are consolidated if Company ownership, directly or indirectly, represents a majority interest (greater than 50%). The Company records redeemable noncontrolling interests in consolidated investments for which the Company’s ownership is less than 100%. The Company has
consolidated the ETF, the Diamond Hill Core Bond Fund, the Diamond Hill High Yield Fund, and the Diamond Hill Global Fund (collectively, the “Consolidated Funds”) as of
December 31, 2018
.
We adopted ASU 2015-02 utilizing the modified retrospective transition method and have recorded a cumulative-effect adjustment to equity of
$4.0 million
as of January 1, 2016. Prior to the adoption of ASU 2015-02, we performed our analysis at the Trust level and concluded we did not need to consolidate the Funds or the ETF as we owned less than 1% of the voting interest in the respective Trusts.
DHCM is the managing member of Diamond Hill General Partner, LLC (the “General Partner”), which is the general partner of Diamond Hill Investment Partners, L.P. (“DHIP”), and Diamond Hill International Equity Fund, L.P. (“DHIEF”), each a limited partnership (collectively, the “Partnerships” or “LPs”) whose underlying assets consist primarily of marketable securities.
DHCM is wholly owned by the Company and is consolidated by us. Further, DHCM, through its control of the General Partner, has the power to direct each LP’s economic activities and the right to receive investment advisory fees that may be significant to the LPs.
The Company concluded we did not have a variable interest in DHIP as the fees paid to the General Partner are considered to contain customary terms and conditions as found in the market for similar products and the Company has no equity ownership in DHIP.
The Company concluded DHIEF was a variable interest entity (“VIE”) as DHCM has disproportionately less voting interest than economic interest, given that the limited partners have full power to remove the Company as the General Partner due to the existence of substantive kick-out rights. In addition, substantially all of the LPs’ activities are conducted on behalf of the General Partner which has disproportionately few voting rights. The Company concluded it is not the primary beneficiary of DHIEF as we lack the power to control the entity due to the existence of single-party kick-out rights where the limited partners have the unilateral ability to remove the General Partner without cause. DHCM’s investments in DHIEF are reported as a component of the Company’s investment portfolio, valued at DHCM’s respective share of the net income or loss of DHIEF.
The LPs are not subject to lock-up periods and can be redeemed on demand. Gains and losses attributable to changes in the value of DHCM’s interests in the LPs are included in the Company’s reported investment income. The Company’s exposure to loss as a result of its involvement with the LPs is limited to the amount of its investments. DHCM is not obligated to provide, and has not provided, financial or other support to the LPs, other than its investments to date and its contractually provided investment advisory responsibilities. The Company has not provided liquidity arrangements, guarantees or other commitments to support the LPs’ operations, and the LPs’ creditors and interest holders have no recourse to the general credit of the Company.
Certain board members and employees of the Company invest in the LPs and are not subject to a management fee or an incentive fee. These individuals receive no remuneration as a result of their personal investment in the LPs. The capital of the General Partner is not subject to a management fee or an incentive fee.
Redeemable Noncontrolling Interest
Redeemable noncontrolling interest represents third-party interests in the Consolidated Funds. This interest is redeemable at the option of the investors and therefore is not treated as permanent equity. Redeemable noncontrolling interest is recorded at redemption value, which approximates the fair value each reporting period.
Segment Information
Management has determined that the Company operates in
one
business segment, providing investment management and administration services to mutual funds, institutional accounts, and private investment funds. Therefore, no disclosures relating to operating segments are presented in the annual financial statements.
Cash and Cash Equivalents
Cash and cash equivalents include demand deposits and money market mutual funds held by DHCM.
Accounts Receivable
Accounts receivable are recorded when they are due and are presented on the balance sheet net of any allowance for doubtful accounts. Accounts receivable are written off when they are determined to be uncollectible. Any allowance for doubtful accounts is estimated based on the Company’s historical losses, existing conditions in the industry, and the financial stability of the individuals or entities that owe the receivable.
No
allowance for doubtful accounts was deemed necessary at
December 31, 2018
or
2017
. Accounts receivable from the Funds were
$9.4 million
and
$11.6 million
as of
December 31, 2018
and
2017
, respectively.
Investments
Management determines the appropriate classification of its investments at the time of purchase and re-evaluates its determination at each reporting period.
Investments in the Funds we advise where the Company has neither control nor the ability to exercise significant influence, as well as securities held in the Consolidated Funds, are measured at fair value based on quoted market prices. Unrealized gains and losses are recorded as investment income (loss) in the Company’s consolidated statements of income.
Investments classified as equity method investments represent investments in which the Company owns between 20-50% of the outstanding voting interests in the entity or when it is determined that the Company is able to exercise significant influence but not control over the investments. When using the equity method, the Company recognizes its respective share of the investee’s net income or loss for the period which is recorded as investment income in the Company’s consolidated statements of income.
Property and Equipment
Property and equipment, consisting of leasehold improvements, computer equipment, furniture, and fixtures, are carried at cost less accumulated depreciation. Accumulated depreciation was
$5.2 million
and
$4.0 million
as of
December 31, 2018
and
2017
, respectively. Depreciation is calculated using the straight-line method over the estimated lives of the assets.
New Accounting Guidance
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers”, which superseded existing accounting standards for revenue recognition and created a single framework. ASU 2014-09 requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. This standard also specifies the accounting for certain costs to obtain or fulfill a contract with a customer. Our implementation efforts included a detailed review of revenue contracts within the scope of the guidance and an evaluation of the impact on the Company’s revenue recognition policies. No transition-related practical expedients were applied. The Company adopted this ASU on its effective date, January 1, 2018, and it had no impact on the timing of the Company’s revenue recognition.
Revenue Recognition – General
Revenue is recognized when performance obligations under the terms of a contract with a client are satisfied. The Company earns substantially all of its revenue from investment advisory and fund administration contracts. Investment advisory and administration fees, generally calculated as a percentage of assets under management (“AUM”), are recorded as revenue as services are performed. In addition to fixed fees based on a percentage of AUM, certain client accounts also provide periodic variable rate fees.
Revenue earned for the years ended
December 31, 2018
,
2017
and
2016
under contracts with clients include:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, 2018
|
|
Investment advisory
|
|
Mutual fund
administration, net
|
|
Total revenue
|
Proprietary funds
|
$
|
105,228,977
|
|
|
$
|
10,309,943
|
|
|
$
|
115,538,920
|
|
Sub-advised funds and institutional accounts
|
30,088,828
|
|
|
—
|
|
|
30,088,828
|
|
|
$
|
135,317,805
|
|
|
$
|
10,309,943
|
|
|
$
|
145,627,748
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, 2017
|
|
Investment advisory
|
|
Mutual fund
administration, net
|
|
Total revenue
|
Proprietary funds
|
$
|
104,233,581
|
|
|
$
|
12,513,267
|
|
|
$
|
116,746,848
|
|
Sub-advised funds and institutional accounts
|
28,454,881
|
|
|
—
|
|
|
28,454,881
|
|
|
$
|
132,688,462
|
|
|
$
|
12,513,267
|
|
|
$
|
145,201,729
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, 2016
|
|
Investment advisory
|
|
Mutual fund
administration, net
|
|
Total revenue
|
Proprietary funds
|
$
|
88,861,650
|
|
|
$
|
14,457,926
|
|
|
$
|
103,319,576
|
|
Sub-advised funds and institutional accounts
|
32,783,499
|
|
|
—
|
|
|
32,783,499
|
|
|
$
|
121,645,149
|
|
|
$
|
14,457,926
|
|
|
$
|
136,103,075
|
|
Revenue Recognition – Investment Advisory Fees
The Company’s investment advisory contracts have a single performance obligation (the investment advisory services provided to the client) as the promised services are not separately identifiable from other promises in the contracts and, therefore, are not distinct. All performance obligations to provide advisory services are satisfied over time and the Company recognizes revenue as time passes.
The fees we receive for our services under our investment advisory contracts are based on our AUM, which changes based on the value of securities held under each advisory contract. These fees are thereby constrained and represent variable consideration, and are excluded from revenue until the AUM on which our client is billed is no longer subject to market fluctuations.
Revenue Recognition – Variable Rate Fees
The Company manages certain client accounts that provide for variable rate fees. These fees are calculated based on client investment results over rolling
five
-year periods. The Company records variable rate fees at the end of the contract measurement period because the variable fees earned are constrained based on movements in the financial markets. During the years ended
December 31, 2018
,
2017
, and
2016
, the Company recorded
$1.4 million
,
$0.2 million
, and
$6.4 million
, respectively, in variable rate fees. The table below shows AUM subject to variable rate fees and the amount of variable rate fees that would be recognized based upon investment results as of
December 31, 2018
:
|
|
|
|
|
|
|
|
|
|
As of December 31, 2018
|
|
AUM subject to variable rate fees
|
|
Unearned variable rate fees
|
Contractual Period Ending:
|
|
|
|
Quarter Ending September 30, 2019
|
$
|
31,391,099
|
|
|
$
|
563,958
|
|
Quarter Ending March 31, 2020
|
11,224,113
|
|
|
10,585
|
|
Quarter Ending September 30, 2021
|
247,707,871
|
|
|
4,062,773
|
|
Total
|
$
|
290,323,083
|
|
|
$
|
4,637,316
|
|
The contractual end dates highlight the time remaining until the variable rate fees are scheduled to be earned. The amount of variable rate fees that would be recognized based upon investments results as of
December 31, 2018
will increase or decrease based on future client investment results through the contractual period end. There can be no assurance that the unearned amounts will ultimately be earned.
Revenue Recognition – Mutual Fund Administration
DHCM has an administrative and transfer agency services agreement with the Funds under which DHCM performs certain services for each Fund. These services include performance obligations including mutual fund administration, fund accounting, transfer agency and other related functions. These services are performed concurrently under our agreement with the Funds, and all performance obligations to provide these administrative services are satisfied over time, and the Company recognizes revenue as time passes. For performing these services each Fund pays DHCM a fee, which is calculated using an annual rate times the average daily net assets of each respective share class. These fees are thereby constrained and represent variable consideration, and are excluded from revenue until the AUM on which we bill the Funds is no longer subject to market fluctuations.
The Funds have selected and contractually engaged certain vendors to fulfill various services to benefit the Funds’ shareholders or to satisfy regulatory requirements of the Funds. These services include, among others, required shareholder mailings, federal and state registrations, and legal and audit services. DHCM, in fulfilling a portion of its role under the administration agreement with the Funds, acts as agent to pay these obligations of the Funds. Each vendor is independently responsible for fulfillment of the services it has been engaged to provide and negotiates fees and terms with the management and board of trustees of the Funds. The fee that each Fund pays to DHCM is reviewed annually by the Funds’ board of trustees and specifically takes into account the contractual expenses that DHCM pays on behalf of the Funds. As a result, DHCM is not involved in the delivery or pricing of these services and bears no risk related to these services. Revenue has been recorded net of these Fund related expenses. In addition, DHCM advances the upfront commissions that are paid to brokers who sell Class C shares of the Funds. These advances are capitalized and amortized over
12 months
to correspond with the repayments DHCM receives from the principal underwriter to recoup this commission advancement.
Prior to the sale of Beacon Hill, the Company, through Beacon Hill, had underwriting and administrative service agreements with certain clients, including registered mutual funds. The fee arrangements varied from client to client based upon services provided and have been recorded as revenue under mutual fund administration on the Company’s consolidated statements of income. Part of Beacon Hill’s role as underwriter was to act as an agent on behalf of its mutual fund clients to receive 12b-1/service fees and commission revenue and facilitate the payment of those fees and commissions to third parties who provide services to the funds and their shareholders. The majority of 12b-1/service fees were paid to independent third parties and the remainder were retained by the Company as a reimbursement of expenses the Company had incurred. The amounts of 12b-1/service fees and commissions were determined by each mutual fund client, and Beacon Hill bore no financial risk related to these services. As a result, 12b-1/service fees and commission revenue was recorded net of the expense payments to third parties, in accordance with the appropriate accounting treatment for this agency relationship.
Mutual fund administration gross and net revenue are summarized below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2018
|
|
2017
|
|
2016
|
Mutual fund administration:
|
|
|
|
|
|
Administration revenue, gross
|
$
|
24,463,538
|
|
|
$
|
26,219,881
|
|
|
$
|
26,664,635
|
|
12b-1/service fees and commission revenue received from fund clients
|
—
|
|
|
—
|
|
|
6,360,400
|
|
12b-1/service fees and commission expense payments to third parties
|
—
|
|
|
—
|
|
|
(5,660,430
|
)
|
Fund related expense
|
(14,183,370
|
)
|
|
(13,748,445
|
)
|
|
(12,937,067
|
)
|
Revenue, net of related expenses
|
10,280,168
|
|
|
12,471,436
|
|
|
14,427,538
|
|
DHCM C-Share financing:
|
|
|
|
|
|
Broker commission advance repayments
|
332,680
|
|
|
416,614
|
|
|
691,228
|
|
Broker commission amortization
|
(302,905
|
)
|
|
(374,783
|
)
|
|
(660,840
|
)
|
Financing activity, net
|
29,775
|
|
|
41,831
|
|
|
30,388
|
|
Mutual fund administration revenue, net
|
$
|
10,309,943
|
|
|
$
|
12,513,267
|
|
|
$
|
14,457,926
|
|
Mutual fund administrative net revenue from the Funds was
$10.3 million
,
$12.5 million
, and
$11.9 million
for the years ended
December 31, 2018
,
2017
and
2016
, respectively.
Income Taxes
The Company accounts for current and deferred income taxes through an asset and liability approach. Deferred tax assets are recognized for deductible temporary differences and deferred tax liabilities are recognized for taxable temporary differences. Deferred tax assets are reduced by a valuation allowance when it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.
The Company is subject to examination by federal and applicable state and local jurisdictions for various tax periods. The Company’s income tax positions are based on research and interpretations of the income tax laws and rulings in each of the jurisdictions in which it does business. Due to the subjectivity of interpretations of laws and rulings in each jurisdiction, the differences and interplay in tax laws among those jurisdictions, and the inherent uncertainty in estimating the final resolution of complex tax audit matters, the Company’s estimates of income tax liabilities may differ from actual payments or assessments. The Company regularly assesses its position with regard to tax exposures and records liabilities for these uncertain tax positions and related interest and penalties, if any, according to the principles of FASB ASC 740,
Income Taxes
. The Company records interest and penalties within income tax expense on the income statement. See
Note 8
.
Earnings Per Share
Basic earnings per share (“EPS”) excludes dilution and is computed by dividing net income by the weighted average number of common shares outstanding for the period, which includes participating securities. Diluted EPS reflects the potential dilution of EPS due to unvested restricted stock units. See
Note 9
.
Newly Issued But Not Yet Adopted Accounting Guidance
In February 2016, the FASB issued ASU 2016-02, “Leases”, which, among other things, requires lessees to recognize most leases on-balance sheet. This will increase the reported assets and liabilities of lessees - in some cases significantly. Lessor accounting remains substantially similar to current GAAP. ASU 2016-02 supersedes Topic 840,
Leases
. ASU 2016-02 is effective for annual and interim periods in fiscal years beginning after December 15, 2018. ASU 2016-02 mandates a modified retrospective transition method for all entities. We will adopt this standard on its effective date, January 1, 2019. While we continue evaluating the full impact this standard will have on our consolidated financial statements, we expect to record a right-of use asset and lease liability of approximately
$3.6 million
related to our office lease. We expect the adoption will have no impact on our consolidated statements of income.
In August 2018, the FASB issued ASU No. 2018-13, “Fair Value Measurements.” This update makes certain removals from, changes to and additions to existing disclosure requirements for fair value measurement. ASU 2018-13 does not change fair value measurements already required or permitted by existing standards. ASU 2018-13 is effective for financial statements issued for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Management does not believe that adoption of ASU 2018-13 will materially impact the Company’s financial statements.
Note 3
Investments
The following table summarizes the carrying value of investments as of
December 31, 2018
and
2017
:
|
|
|
|
|
|
|
|
|
|
As of December 31,
|
|
2018
|
|
2017
|
Fair value investments:
|
|
|
|
Securities held in Consolidated Funds
(a)
|
$
|
153,730,480
|
|
|
$
|
65,890,500
|
|
Company sponsored investments
|
33,418,088
|
|
|
36,541,818
|
|
Company sponsored equity method investments
|
16,339,649
|
|
|
36,043,704
|
|
Total Investments
|
$
|
203,488,217
|
|
|
$
|
138,476,022
|
|
(a) Of the securities held in the Consolidated Funds as of
December 31, 2018
,
$84.7 million
were held directly by the Company and
$69.0 million
were held by noncontrolling shareholders. Of the securities held in the Consolidated Funds as of
December 31, 2017
,
$42.6 million
were held directly by the Company and
$23.3 million
were held by noncontrolling shareholders.
The Company consolidated the ETF and Diamond Hill Core Bond Fund as of both
December 31, 2018
and
2017
, respectively. During the year ended
December 31, 2018
, the Company also consolidated the Diamond Hill Global Fund and the Diamond
Hill High Yield Fund as we increased our ownership interest of each above 50% during the year. As of
December 31, 2017
, these investments were classified as equity method investments.
As of
December 31, 2018
, our equity method investments consisted of the Diamond Hill Research Opportunities Fund and the Diamond Hill International Equity Fund, L.P., and our ownership percentages in each of these funds was
28%
and
30%
, respectively. As of
December 31, 2017
, our equity method investments consisted of the Diamond Hill Research Opportunities Fund, the Diamond Hill High Yield Fund, the Diamond Hill Global Fund, L.P., and the Diamond Hill International Equity Fund, L.P., and our ownership percentages in these funds were
26%
,
48%
,
95%
, and
30%
, respectively. The Company’s equity method investments consist of cash, marketable equity securities and fixed income securities. The following table includes the condensed summary financial information from the Company’s equity method investments as of
December 31, 2018
and
2017
and for the years ended
December 31, 2018
,
2017
and
2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31,
|
|
|
|
2018
|
|
2017
|
Total assets
|
|
|
$
|
80,845,124
|
|
|
$
|
144,118,745
|
|
Total liabilities
|
|
|
22,287,437
|
|
|
38,009,765
|
|
Net assets
|
|
|
58,557,687
|
|
|
106,108,980
|
|
DHCM’s portion of net assets
|
|
|
16,339,649
|
|
|
36,043,704
|
|
|
|
|
|
|
|
|
For the Year Ended December 31,
|
|
2018
|
|
2017
|
|
2016
|
Investment income
|
$
|
1,154,007
|
|
|
$
|
2,944,836
|
|
|
$
|
3,272,972
|
|
Expenses
|
978,322
|
|
|
1,176,896
|
|
|
1,409,896
|
|
Net realized gains
|
1,918,661
|
|
|
4,432,850
|
|
|
1,981,185
|
|
Net change in unrealized appreciation (depreciation)
|
(10,229,319
|
)
|
|
5,613,627
|
|
|
10,458,073
|
|
Net income
|
(8,134,973
|
)
|
|
11,814,417
|
|
|
14,302,334
|
|
DHCM’s portion of net income
|
(2,400,467
|
)
|
|
3,206,702
|
|
|
4,392,636
|
|
Note 4
Fair Value Measurements
The Company determines the fair value of our cash equivalents and certain investments using the following broad levels listed below:
Level 1 - Unadjusted quoted prices for identical instruments in active markets.
Level 2 - Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-driven valuations in which all significant inputs are observable.
Level 3 - Valuations derived from techniques in which significant inputs are unobservable. We do not value any investments using Level 3 inputs.
These levels are not necessarily an indication of the risk or liquidity associated with investments.
The following table summarizes investments that are recognized in our consolidated balance sheet using fair value measurements (excludes investments classified as equity method investments) determined based upon the differing levels as of
December 31, 2018
and
2017
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2018
|
Level 1
|
Level 2
|
Level 3
|
Total
|
Cash equivalents
|
$
|
80,690,647
|
|
$
|
—
|
|
$
|
—
|
|
$
|
80,690,647
|
|
Fair value investments
|
|
|
|
|
Securities held in Consolidated Funds
(a)
|
43,595,438
|
|
110,135,042
|
|
—
|
|
$
|
153,730,480
|
|
Company sponsored investments
|
33,418,088
|
|
—
|
|
—
|
|
$
|
33,418,088
|
|
|
|
|
|
|
December 31, 2017
|
|
|
|
|
Cash equivalents
|
72,669,083
|
|
—
|
|
—
|
|
$
|
72,669,083
|
|
Fair value investments
|
|
|
|
|
Securities held in Consolidated Funds
(a)
|
24,618,578
|
|
41,271,922
|
|
—
|
|
$
|
65,890,500
|
|
Company sponsored investments
|
36,541,818
|
|
—
|
|
—
|
|
$
|
36,541,818
|
|
(a) Of the securities held in the Consolidated Funds as of
December 31, 2018
,
$84.7 million
were held directly by the Company and
$69.0 million
were held by noncontrolling shareholders. Of the securities held in the Consolidated Funds as of
December 31, 2017
,
$42.6 million
were held directly by the Company and
$23.3 million
were held by noncontrolling shareholders.
Level 1 investments are comprised of investments in registered investment companies (mutual funds) or equity securities held in the Consolidated Funds and include, as of
December 31, 2018
and
2017
,
$80.7 million
and
$72.7 million
, respectively, of investments in money market mutual funds owned by DHCM that the Company classifies as cash equivalents.
Level 2 investments are comprised of investments in debt securities held in the Consolidated Funds, which are valued by an independent pricing service using pricing techniques which take into account factors such as trading activity, readily available market quotations, yield, quality, coupon rate, maturity, type of issue, trading characteristics, call features, credit rates and other observable inputs.
The Company determines transfers between fair value hierarchy levels at the end of the reporting period. There were no transfers in or out of the levels during any of the years ended
December 31, 2018
,
2017
, and
2016
.
Changes to fair values of the investments are recorded in the Company’s consolidated statements of income as investment income (loss), net.
Note 5
Capital Stock
Common Shares
The Company has only one class of securities outstanding, common shares, no par value per share.
Authorization of Preferred Shares
The Company’s Amended and Restated Articles of Incorporation authorize the issuance of
1,000,000
“blank check” preferred shares with such designations, rights and preferences as may be determined from time to time by the Company’s Board of Directors. The Board of Directors is authorized, without shareholder approval, to issue preferred shares with dividend, liquidation, conversion, voting, or other rights, which could adversely affect the voting or other rights of the holders of the common shares. There were no shares of preferred shares issued or outstanding at
December 31, 2018
or
2017
.
Note 6
Compensation Plans
Equity Incentive Plans
2014 Equity and Cash Incentive Plan
At the Company’s annual shareholder meeting on April 30, 2014, shareholders approved the 2014 Equity and Cash Incentive Plan (“2014 Plan”). The 2014 Plan is intended to facilitate the Company’s ability to attract and retain staff, provide additional incentive to employees and directors, and promote the success of the Company’s business. The 2014 Plan authorizes the
issuance of
600,000
common shares of the Company in various forms of equity awards. The 2014 Plan also authorizes cash incentive awards. As of
December 31, 2018
, there were
287,354
common shares available for awards under the 2014 Plan. The 2014 Plan provides that the Board of Directors, or a committee appointed by the Board, may grant awards and otherwise administer the 2014 Plan. Restricted stock units and restricted stock grants issued under the 2014 Plan, which vest over time, are recorded as deferred compensation in the equity section of the balance sheet on the grant date and then recognized as compensation expense based on the grant date price over the vesting period of the respective grant. Stock grants issued under the 2014 Plan are recorded as compensation expense based on the grant date price.
2011 Equity and Cash Incentive Plan
There are no longer any common shares available for future awards under the 2011 Equity and Cash Incentive Plan (the “2011 Plan”), although awards granted under the 2011 plan remain issued and outstanding. Restricted stock grants issued under the 2011 Plan, which vest over time, were recorded as deferred compensation in the equity section of the balance sheet on the grant date and then recognized as compensation expense based on the grant date price over the vesting period of the respective grant. Stock grants issued under the 2011 Plan were recorded as compensation expense based on the grant date price.
Share-Based Payment Transactions
The Company issues restricted stock units and restricted stock awards (sometimes referred to collectively as, “Restricted Stock”) under the 2014 Plan. Restricted stock units represent common shares which may be issued in the future, whereas restricted stock awards represent common shares issued and outstanding upon grant subject to vesting restrictions. The following table represents a roll-forward of outstanding Restricted Stock and related activity during the years ended
December 31, 2018
and
2017
:
|
|
|
|
|
|
|
|
|
Shares
|
|
Weighted-Average
Grant Date Price
per Share
|
Outstanding Restricted Stock as of December 31, 2016
|
223,800
|
|
|
$
|
132.96
|
|
Grants issued
|
41,350
|
|
|
204.46
|
|
Grants vested
|
(65,500
|
)
|
|
98.81
|
|
Grants forfeited
|
(1,750
|
)
|
|
100.73
|
|
Outstanding Restricted Stock as of December 31, 2017
|
197,900
|
|
|
$
|
165.60
|
|
Grants issued
|
70,025
|
|
|
195.00
|
|
Grants vested
|
(32,450
|
)
|
|
82.30
|
|
Grants forfeited
|
(20,900
|
)
|
|
196.97
|
|
Outstanding Restricted Stock as of December 31, 2018
|
214,575
|
|
|
$
|
177.22
|
|
Total deferred equity compensation related to unvested Restricted Stock grants was
$22.0 million
as of
December 31, 2018
. Compensation expense related to Restricted Stock grants is calculated based upon the fair market value of the common shares on grant date. The Company’s policy is to adjust compensation expense for forfeitures as they occur. The recognition of compensation expense related to deferred compensation over the remaining vesting periods is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2019
|
|
2020
|
|
2021
|
|
2022
|
|
2023
|
|
Thereafter
|
|
Total
|
$
|
7,135,131
|
|
|
$
|
5,671,192
|
|
|
$
|
4,358,633
|
|
|
$
|
3,371,500
|
|
|
$
|
1,129,611
|
|
|
$
|
341,987
|
|
|
$
|
22,008,054
|
|
Stock Grant Transactions
The following table represents shares issued as part of our incentive compensation program during the years ended
December 31, 2018
,
2017
, and
2016
:
|
|
|
|
|
|
|
|
|
Shares Issued
|
|
Grant Date Value
|
December 31, 2018
|
20,153
|
|
|
$
|
4,109,197
|
|
December 31, 2017
|
19,219
|
|
|
3,892,424
|
|
December 31, 2016
|
21,940
|
|
|
3,879,431
|
|
401(k) Plan
The Company sponsors a 401(k) plan in which all employees are eligible to participate. Employees may contribute a portion of their compensation subject to certain limits based on federal tax laws. Effective April 1, 2018, the Company increased its matching contributions of common shares of the Company with a value equal to
250 percent
of the first
six percent
of an employee’s compensation contributed to the plan. Prior to April 1, 2018, the Company made matching contributions of common shares of the Company with a value equal to
200 percent
of the first
six percent
of an employee’s compensation contribution to the plan. Employees become fully vested in the matching contributions after
six
plan years of employment. The following table summarizes the Company’s expenses attributable to the 401(k) plan during the years ended
December 31, 2018
,
2017
and
2016
:
|
|
|
|
|
|
|
|
|
Shares Issued
|
|
Company Contribution
|
December 31, 2018
|
11,967
|
|
|
$
|
2,231,735
|
|
December 31, 2017
|
8,478
|
|
|
1,710,785
|
|
December 31, 2016
|
9,466
|
|
|
1,738,287
|
|
Deferred Compensation Plans
The Company offers two deferred compensation plans, the Diamond Hill Fixed Term Deferred Compensation Plan and the Diamond Hill Variable Term Deferred Compensation Plan (collectively the “Plans”). Under the Plans, participants may elect to voluntarily defer, for a minimum of
five
years, certain incentive compensation, which the Company then contributes into the Plans. Each participant is responsible for designating investment options for assets they contribute, and the distribution paid to each participant reflects any gains or losses on the assets realized while in the Plans. Assets held in the Plans are included in the Company’s investment portfolio, and the associated obligation to participants is included in deferred compensation liability. Deferred compensation liability was
$22.4 million
and
$20.5 million
as of
December 31, 2018
and
2017
, respectively.
Note 7
Operating Leases
The Company currently leases office space of approximately
37,829
square feet at
one
location. The following table summarizes the total lease and operating expenses for the years ended
December 31, 2018
,
2017
and
2016
:
|
|
|
|
|
|
|
|
|
|
|
|
For the year ended December 31,
|
2018
|
|
2017
|
|
2016
|
$
|
970,143
|
|
|
$
|
936,008
|
|
|
$
|
882,231
|
|
The approximate future minimum lease payments under the operating lease are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Future Minimum Lease Payments by Year
|
Total
|
|
2019
|
|
2020
|
|
2021
|
|
2022
|
|
2023
|
|
Thereafter
|
$
|
3,853,831
|
|
|
$
|
586,350
|
|
|
$
|
614,721
|
|
|
$
|
624,179
|
|
|
$
|
624,179
|
|
|
$
|
624,179
|
|
|
$
|
780,223
|
|
In addition to the above lease payments, the Company is also responsible for normal operating expenses of the property. Such annual operating expenses were approximately
$0.4 million
in each of
2018
,
2017
and
2016
.
Note 8
Income Taxes
The provision for income taxes consists of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31,
|
|
2018
|
|
2017
|
|
2016
|
Current federal income tax provision
|
$
|
15,731,258
|
|
|
$
|
24,749,832
|
|
|
$
|
24,234,050
|
|
Current state and local income tax provision
|
8,560,479
|
|
|
1,774,395
|
|
|
1,964,273
|
|
Deferred income tax expense (benefit)
|
(5,622,396
|
)
|
|
2,893,063
|
|
|
469,312
|
|
Provision for income taxes
|
$
|
18,669,341
|
|
|
$
|
29,417,290
|
|
|
$
|
26,667,635
|
|
A reconciliation of income tax expense at the statutory federal rate to the Company’s income tax expense is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2018
|
|
2017
|
|
2016
|
Income tax computed at statutory rate
|
$
|
13,646,583
|
|
|
$
|
28,356,636
|
|
|
$
|
25,641,618
|
|
Expense (benefit) attributable to redeemable noncontrolling interests
(a)
|
222,624
|
|
|
(564,449
|
)
|
|
(189,773
|
)
|
State and local income taxes, net of federal benefit
|
2,993,730
|
|
|
1,153,357
|
|
|
1,276,777
|
|
Change in uncertain state and local tax positions, net of federal benefit
|
2,982,337
|
|
|
—
|
|
|
—
|
|
Revaluation adjustment of net deferred tax assets
(b)
|
(917,288
|
)
|
|
3,557,039
|
|
|
—
|
|
Excess tax benefits on vesting of Restricted Stock
|
(667,697
|
)
|
|
(2,420,250
|
)
|
|
—
|
|
Income tax benefit from dividends paid on Restricted Stock
|
(340,200
|
)
|
|
(418,583
|
)
|
|
—
|
|
Interest and Penalties
|
786,711
|
|
|
—
|
|
|
15,748
|
|
Other
|
(37,459
|
)
|
|
(246,460
|
)
|
|
(76,735
|
)
|
Income tax expense
|
$
|
18,669,341
|
|
|
$
|
29,417,290
|
|
|
$
|
26,667,635
|
|
(a) The provision for income taxes includes expense (benefit) attributable to the fact that the Company’s operations include the Consolidated Funds which are not subject to federal income taxes. Accordingly, a portion of the Company’s earnings are not subject to corporate tax levels.
(b) The provision for income taxes for 2018 includes the remeasurement of our net deferred tax assets of
$0.9 million
due to the additional state and local tax we expect to pay in future tax periods. The provision for income taxes for 2017 includes a non-recurring charge of
$3.6 million
for the remeasurement of our net deferred tax assets to reflect the effect of the U.S. tax law changes enacted on December 22, 2017.
Deferred income taxes and benefits arise from temporary differences between taxable income for financial statement and income tax return purposes. Net deferred tax assets consisted of the following at
December 31, 2018
and
2017
:
|
|
|
|
|
|
|
|
|
|
2018
|
|
2017
|
Stock-based compensation
|
$
|
4,025,255
|
|
|
$
|
2,868,719
|
|
Accrued compensation
|
6,684,531
|
|
|
5,795,204
|
|
Unrealized losses (gains)
|
1,323,181
|
|
|
(2,260,673
|
)
|
Property and equipment
|
(498,271
|
)
|
|
(467,127
|
)
|
Other assets and liabilities
|
(68,596
|
)
|
|
(92,419
|
)
|
Net deferred tax assets
|
$
|
11,466,100
|
|
|
$
|
5,843,704
|
|
The net temporary differences incurred to date will reverse in future periods as the Company generates taxable earnings. The Company believes it is more likely than not that the results of future operations will generate sufficient taxable income to realize the net deferred tax assets recorded. The Company records a valuation allowance when it is more likely than not that some portion or all of the deferred tax assets will not be realized. As of
December 31, 2018
,
no
valuation allowance was deemed necessary.
The Company implemented ASU 2016-09, “Improvements to Employee Share-Based Payment Accounting” on January 1, 2017. Beginning January 1, 2017, any excess tax benefits or deficiencies from the vesting of stock awards are recognized through the income tax provision as opposed to common stock. For Restricted Stock, the Company receives an excess income tax benefit calculated as the tax effect of the difference between the fair market value of the stock at the time of grant and vesting. The Company also records income tax benefits from dividends paid on Restricted Stock. This change was required to be applied prospectively to all excess tax benefits and tax deficiencies after the date of adoption of the ASU. No adjustment is recorded for any windfall benefits previously recorded in common stock. In addition, all tax-related cash flows resulting from share based payments are now reported as operating activities in the statement of cash flows under the new guidance, rather than the prior requirement to present windfall tax benefits as an inflow from financing activities and an outflow from operating activities. The Company elected to adopt this change in cash flow presentation prospectively after the date of adoption of the ASU beginning January 1, 2017.
Prior to January 1, 2017, the Company’s income taxes payable has been reduced by the tax benefits from equity incentive plan awards. These tax benefits were considered windfall tax benefits and were recognized as an increase to common stock. For Restricted Stock, the Company receives an excess income tax benefit calculated as the tax effect of the difference between the fair market value of the stock at the time of grant and vesting. The Company also records a tax benefit on dividends paid on Restricted Stock during the vesting period. The Company had net tax benefits from equity awards of
$6.3 million
for the year ended December 31, 2016.
FASB ASC 740,
Income
Taxes, prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return and also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The Company recognizes tax benefits related to positions taken, or expected to be taken, on its tax returns, only if the positions are "more-likely-than-not" sustainable. Once this threshold has been met, the Company’s measurement of its expected tax benefits is recognized in its financial statements.
There was a
$3.0 million
increase to the total amount of unrecognized tax benefits related to tax uncertainties during 2018. The increase was the result of tax positions taken regarding state tax apportionment issues based on management’s judgment and latest information available.
The Company and its subsidiaries file income tax returns with the Internal Revenue Service and the taxing authorities of various states. Generally the Company is subject to federal, state and local examinations by tax authorities for the tax years ended December 31, 2014 through 2018. The Company is currently under examination for tax years 2014 through 2016 with the New York State Department of Finance and Taxation. The New York State Department of Finance and Taxation issued a Consent to Field Audit Adjustment which means the Company and the New York State Department of Finance and Taxation are nearing the completion of the examination, however, the examination was not completed as of December 31, 2018. During 2018, the Company reassessed its New York City filing positions and filed a Voluntary Disclosure Agreement with the New York City Department of Finance. During 2018, the California Franchise Tax Board started the audit of the Company’s 2015 and 2016 tax years. No Notices of Proposed Assessments have been issued by the California Franchise Tax Board by December 31, 2018 and the audit is ongoing.
The outcome of these examinations is not expected to have a material impact on the Company’s financial statements. The Company believes that some of these audits and negotiations will conclude within the next 12 months and that it is reasonably possible the amount of uncertain tax positions, including interest, may change by an immaterial amount due to settlements of audits.
The amount of uncertain tax positions as of
December 31, 2018
,
2017
and
2016
, respectively, which would impact the Company’s effective tax rate if recognized and a reconciliation of the beginning and ending amounts of uncertain tax positions is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2018
|
|
2017
|
|
2016
|
Uncertain tax positions, beginning of the year
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Gross addition for tax positions of the current year
|
—
|
|
|
—
|
|
|
—
|
|
Gross additions for tax positions of prior years
|
2,982,337
|
|
|
—
|
|
|
—
|
|
Uncertain tax positions, end of year
|
$
|
2,982,337
|
|
|
$
|
—
|
|
|
$
|
—
|
|
In addition to the above uncertain tax positions, the Company recognized
$0.8 million
of interest and penalties which were accrued for during the year ended
December 31, 2018
. No interest and penalties were accrued for uncertain tax positions during the years ended
December 31, 2017
and
2016
.
Note 9
Earnings Per Share
The Company’s common shares outstanding consist of all shares issued and outstanding, including unvested restricted shares. Basic and diluted EPS are calculated under the two-class method. Restricted stock units are considered dilutive. The following table sets forth the computation for basic and diluted EPS and reconciliation between basic and diluted shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2018
|
|
2017
|
|
2016
|
Net Income
|
$
|
46,314,388
|
|
|
$
|
51,601,669
|
|
|
$
|
46,594,132
|
|
Less: Net loss (income) attributable to redeemable noncontrolling interest
|
1,061,441
|
|
|
(1,612,712
|
)
|
|
(542,209
|
)
|
Net income attributable to common shareholders
|
$
|
47,375,829
|
|
|
$
|
49,988,957
|
|
|
$
|
46,051,923
|
|
|
|
|
|
|
|
Weighted average number of outstanding shares
|
3,512,470
|
|
|
3,448,824
|
|
|
3,407,408
|
|
Dilutive impact of restricted stock units
|
2,058
|
|
|
3,014
|
|
|
5,983
|
|
Weighted average number of outstanding shares - Diluted
|
3,514,528
|
|
|
3,451,838
|
|
|
3,413,391
|
|
|
|
|
|
|
|
Earnings per share attributable to common shareholders
|
|
|
|
|
|
Basic
|
$
|
13.49
|
|
|
$
|
14.49
|
|
|
$
|
13.52
|
|
Diluted
|
$
|
13.48
|
|
|
$
|
14.48
|
|
|
$
|
13.49
|
|
Note 10
Commitments and Contingencies
The Company indemnifies its directors, officers and certain of its employees for certain liabilities that might arise from their performance of their duties to the Company. From time to time, the Company is involved in legal matters relating to claims arising in the ordinary course of business. There are currently no such matters pending that the Company believes could have a material adverse effect on its consolidated financial statements.
Additionally, in the normal course of business, the Company enters into agreements that contain a variety of representations and warranties and which provide general indemnifications. Certain agreements do not contain any limits on the Company’s liability and could involve future claims that may be made against the Company that have not yet occurred. Therefore, it is not possible to estimate the Company’s potential liability under these indemnities. Further, the Company maintains insurance policies that may provide coverage against certain claims under these indemnities.
Note 11
Sale of Beacon Hill
On June 15, 2016, the Company sold the entirety of Beacon Hill’s business. The Company received
$1.2 million
in cash consideration, net of cash disposed, as well as contingent consideration with a fair value of
$1.5 million
in the form of a promissory note. The Company recorded a gain on sale of approximately
$2.7 million
during 2016. The Company collected
$0.5 million
and
$1.0 million
in the years ended
December 31, 2018
and
2017
, respectively.