DIAMOND HILL INVESTMENT GROUP, INC. In this Item 7, we discuss and analyze our consolidated results of operations for the past three fiscal years and other factors that may affect our future financial performance. This discussion should be read in conjunction with our Consolidated Financial Statements, Notes to Consolidated Financial Statements, and Selected Financial Data contained in this Annual Report on Form 10-K.
Business Environment
The performance of theU.S. and international equity markets, as well as theU.S. fixed income market, have a direct impact on our operations and financial position. 2021 closed out another year of strong gains for equity markets globally. The MSCI All Country World Index advanced 18.5%, with the majority of those returns driven by developed markets as emerging markets stocks fell -2.5% as measured by the MSCI Emerging Markets Index. US markets, as measured by the Russell 3000® Index, rose 25.7%. Early in 2021, we saw continued distribution of COVID-19 vaccines globally, gradual steps to reopening economies, and broad gains in stocks across sectors. As economic recoveries progressed and the pandemic persisted, economies began facing rising inflation, supply chain disruptions and surging energy prices. For only the fourth time in its history, in 2021, theU.S. investment-grade fixed income market (as measured by the BloombergU.S. Aggregate Index) delivered negative returns in a calendar year due largely to a combination of rising rates, economic resurgence post-pandemic shutdowns, and supply/demand dislocations fueling historic inflation levels. TheFederal Reserve gradually shifted from viewing inflation as transitory to a matter that needed to be actively addressed, accelerating expectations for rate hikes from year-end 2021 to early 2022. TheFederal Reserve also shifted its stance on tapering-from discussing it as a potential option to proceeding with executing it-and is now accelerating the process to complete it byMarch 2022 . While the longer end of theTreasury curve experienced gyrations throughout the year as the Delta and Omicron variants of COVID-19 increased investor uncertainty, the shorter end of the curve generally remained anchored. Only after theFederal Reserve began laying the groundwork for tapering and potential rate hikes in 2022 did the two-yearTreasury rate begin to move higher, rising from an average yield of 0.166% from the beginning of the year through the end of August, then climbing through the final four months to finish the year at 0.732%. We continue to believe we can deliver market-beating returns over a full market cycle through active management. Our commitment to managing our portfolios with a strict capacity discipline helps protect our ability to deliver excellent investment outcomes for clients through the use of more concentrated portfolios than the broader market can offer. Our long-standing relationships with professional buyer groups enable us to reach investors who share our long-term perspective. Our priority continues to be helping clients to achieve their desired investment outcomes, and we believe our commitment to capacity discipline, alignment of interests with our clients and strong investment results will result in a successful and sustainable future. Investment Results It is imperative we provide our clients excellent investment returns over long periods of time. We are pleased that during our history as an investment advisory firm, we have delivered what we believe are strong long-term investment returns. Investment returns have been a key driver in the long-term success we have achieved in growing AUM.
The following is a summary of the investment returns for each of our strategies
as of
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As of December 31, 2021
U.S. Equity Composites Inception 1 Year 3 Year 5 Year 10 Year Since Inception
Diamond Hill Large Cap 6/30/2001 25.92 % 22.20 % 14.82 % 14.58 % 10.18 %
Russell 1000 Index 26.45 % 26.21 % 18.43 % 16.54 % 9.18 %
Russell 1000 Value Index 25.16 % 17.64 % 11.16 % 12.97 % 7.89 %
Diamond Hill Large Cap Concentrated 12/31/2011 26.90 % 22.35 % 14.94 % 14.76 % 14.76 %
Russell 1000 Index 26.45 % 26.21 % 18.43 % 16.54 % 16.54 %
Russell 1000 Value Index 25.16 % 17.64 % 11.16 % 12.97 % 12.97 %
Diamond Hill Mid Cap 12/31/2013 31.79 % 17.87 % 10.26 % NA 9.81 %
Russell Midcap Index 22.58 % 23.29 % 15.10 % NA 12.35 %
Russell Midcap Value Index 28.34 % 19.62 % 11.22 % NA 10.55 %
Diamond Hill Small-Mid Cap 12/31/2005 31.40 % 19.52 % 10.25 % 13.34 % 9.89 %
Russell 2500 Index 18.18 % 21.91 % 13.75 % 14.15 % 10.07 %
Russell 2500 Value Index 27.78 % 18.31 % 9.88 % 12.43 % 8.64 %
Diamond Hill Small Cap 12/31/2000 33.13 % 17.52 % 9.00 % 11.09 % 10.85 %
Russell 2000 Index 14.82 % 20.02 % 12.02 % 13.23 % 9.02 %
Russell 2000 Value Index 28.27 % 17.99 % 9.07 % 12.03 % 9.41 %
Diamond Hill Select 6/30/2000 33.56 % 26.23 % 16.44 % 15.58 % 11.35 %
Russell 3000 Index 25.66 % 25.79 % 17.97 % 16.30 % 7.96 %
Russell 3000 Value Index 25.37 % 17.65 % 11.00 % 12.89 % 8.14 %
Alternative Composites
Diamond Hill Long-Short 6/30/2000 20.33 % 14.47 % 8.48 % 9.31 % 7.81 %
Russell 1000 Index 26.45 % 26.21 % 18.43 % 16.54 % 9.18 %
60% Russell 1000 Index / 40% BofA ML
US T-Bill 0-3 Month Index 15.36 % 15.91 % 11.52 % 10.13 % 5.59 %
International Composites
Diamond Hill International 12/31/2016 13.00 % 14.60 % 12.46 % NA 12.46 %
Morningstar Global Markets ex US Index 8.41 % 13.58 % 9.88 % NA 9.88 %
Fixed Income Composites
Diamond Hill Short Duration
Securitized Bond 7/31/2016 2.91 % 3.72 % 3.82 % NA 3.66 %
Bloomberg Barclays US 1-3 Yr.
Gov./Credit Index (0.47) % 2.28 % 1.85 % NA 1.64 %
Diamond Hill Core Bond 7/31/2016 (0.79) % 5.12 % 4.28 % NA 3.45 %
Bloomberg Barclays US Aggregate Index (1.54) % 4.79 % 3.57 % NA 2.68 %
_______________________
- Composite returns are net of fees.
- Index returns do not reflect any fees.
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Key Financial Performance Indicators
There are a variety of key performance indicators that we monitor to evaluate
our business results. The following table presents the results of certain key
performance indicators over the past three fiscal years:
For the Years Ended December 31,
2021 2020 2019
Ending AUM (in millions) $ 31,028 $ 26,411 $ 23,399
Average AUM (in millions) 30,297 21,907 21,653
Net cash inflows (outflows) (in millions) 2,123 1,529 (677)
Total revenue (in thousands) 182,194 126,388 136,624
Net operating income 76,258 45,538 47,935
Net operating income, as adjusted(a) $ 83,340 $ 47,757 $ 53,912
Average advisory fee rate 0.56 % 0.54 % 0.59 %
Average advisory fee rate, excluding performance fees 0.52 % 0.54 % 0.59 %
Operating profit margin 42 % 36 % 35 %
Operating profit margin, as adjusted(a) 46 % 38 % 39 %
(a) Net operating income, as adjusted, and operating profit margin, as adjusted,
are non-GAAP (as defined below) performance measures. See Use of Supplemental
Data as Non-GAAP Performance Measure section within this Annual Report on Form
10-K.
Assets Under Management
The Company derives revenue primarily from DHCM's investment advisory and
administration fees. Investment advisory and administration fees paid to DHCM
are generally based on the value of the investment portfolios it manages and
fluctuate with changes in the total value of its AUM. The Company, through DHCM,
recognizes revenue when it satisfies its performance obligations under the terms
of a contract with a client.
The Company's revenues are highly dependent on both the value and composition of
AUM. The following is a summary of the Company's AUM by product and investment
objective, and a roll-forward of the change in AUM, for the years ended
December 31, 2021 , 2020, and 2019:
Assets Under Management
As of December 31,
(in millions) 2021 2020 2019
Proprietary funds $ 19,802 $ 17,615 $ 16,148
Sub-advised funds 3,994 3,185 2,029
Separately managed accounts 7,232 5,611 5,222
Total AUM $ 31,028 $ 26,411 $ 23,399
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Assets Under Management
by Investment Strategy
As of December 31,
(in millions) 2021 2020 2019
U.S. Equity
Large Cap $ 21,285 $ 15,075 $ 12,316
Small-Mid Cap 3,183 2,810 3,243
Mid Cap 1,165 992 569
Small Cap 597 556 795
All Cap Select 438 446 528
Large Cap Concentrated 64 27 28
Micro Cap 16 - -
Total U.S. Equity 26,748 19,906 17,479
Alternatives
Long-Short 1,998 2,056 3,605
Total Alternatives 1,998 2,056 3,605
Global/International Equity
International 56 17 13
Global(a) - 16 22
Total Global/International Equity 56 33 35
Fixed Income Short Duration Securitized Bond 1,613 1,132 809 Core Fixed Income 622 541 300 Long Duration Treasury 51 62 52 Corporate Credit(b) - 2,020 1,147 High Yield(b) - 724 135 Total Fixed Income 2,286 4,479 2,443 Total-All Strategies 31,088 26,474 23,562
(Less: Investments in affiliated funds)(c) (60) (63)
(163)
Total AUM $ 31,028 $ 26,411 $ 23,399
(a) The Diamond Hill Global Fund was liquidated on December 17, 2021 .
(b) The Diamond Hill Corporate Credit and High Yield investment advisory
contracts (the "High Yield-Focused Advisory Contracts")
were sold to Brandywine Global Investment Management, LLC ("Brandywine Global")
effective July 30, 2021 .
(c) Certain of the Funds own shares of the Diamond Hill Short Duration
Securitized Bond Fund . The Company reduces the total AUM by the investments held
in this affiliated Fund.
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Change in Assets Under Management
For the Year Ended December 31,
(in millions) 2021 2020 2019
AUM at beginning of the year $ 26,411 $ 23,399 $ 19,108
Net cash inflows (outflows)
proprietary funds 2,009 879 (499)
sub-advised funds (54) 713 216
separately managed accounts 168 (63) (394)
2,123 1,529 (677)
Sale of high yield-focused advisory contracts (3,456) - -
Net market appreciation and income 5,950 1,483 4,968
Increase during the year 4,617 3,012 4,291
AUM at end of the year $ 31,028 $ 26,411 $ 23,399
Average AUM during the year $ 30,297 $ 21,907 $ 21,653
Net CashInflows (Outflows) Further Breakdown
For the Year Ended December 31,
(in millions) 2021 2020 2019
Net cash inflows (outflows)
Equity $ 958 $ (284) $ (1,515)
Fixed Income 1,165 1,813 838
$ 2,123 $ 1,529 $ (677) 2021 Discussion of Net Cash Inflows
Both our equity and fixed income strategies experienced net inflows during the year endedDecember 31, 2021 . Flows in our equity strategies were largely driven by our Large Cap strategy, which experienced net inflows of$2.1 billion . These net inflows were partially offset by net outflows from our other equity strategies totaling approximately$1.2 billion . The Company's fixed income strategies, including the High Yield-Focused Advisory Contracts prior to their sale, had net positive flows of$1.2 billion during the year endedDecember 31, 2021 .
2020 Discussion of Net Cash Inflows
Flows into equity strategies were mixed in 2020. Our Large Cap and Mid-Cap strategies had combined net inflows of$1.6 billion . However, these net inflows were more than offset by the net outflows in our Long-Short, Small Cap and Small-Mid Cap strategies, which collectively had outflows of$1.8 billion . Our fixed income strategies continued to see strong growth in 2020 as each of the strategies met long-term performance objectives compared to peers and benchmarks. Our focused marketing and branding efforts, along with strong performance, led to combined net inflows of$1.8 billion , with each of the strategies attracting at least$200 million in net inflows.
2019 Discussion of Cash Outflows
Our fixed income strategies experienced strong growth in 2019 with High Yield reaching its five-year anniversary and Core Bond and Short-Duration reaching three years. Each of our fixed income strategies met long-term performance objectives compared to peers and benchmarks. Additionally, we supplemented our distribution efforts with dedicated resources in marketing and branding specifically for our fixed income strategies. Equity flows experienced a challenging 2019. The net equity outflows can primarily be attributed to underperformance in our closed strategies, as$1.4 billion of the net outflows in 2019 were from our Small Cap, Small-Mid Cap and Long-Short strategies. As a result, we reopened the Small Cap and Long-Short strategies during 2019.
Model Delivery Programs - Assets Under Advisement
DHCM provides strategy-specific model portfolios to sponsors of model delivery
programs. DHCM does not have discretionary investment authority over individual
client accounts in model delivery programs, and therefore, these assets are not
included in
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the Company's AUM. Rather, we refer to these model delivery assets as AUA. DHCM is paid for its services by the program sponsor at a pre-determined rate based on assets in the program. Model delivery program AUA were$2.1 billion ,$1.1 billion , and$0.9 billion as ofDecember 31, 2021 , 2020, and 2019, respectively.
Consolidated Results of Operations
The following is a table and discussion of the Company's consolidated results of operations.
(in thousands, except per share amounts and percentages) 2021 2020 % Change 2020 2019 % Change Total revenue$ 182,194 $ 126,388 44%$ 126,388 $ 136,624 (7)% Net operating income 76,258 45,538 67% 45,538 47,935 (5)% Net operating income, as adjusted (a) 83,340 47,757 75% 47,757 53,912 (11)% Investment income, net 16,381 6,585 149% 6,585 30,507 (78)% Gain on sale of high yield-focused advisory contracts 9,000 - NM - - NM Income tax expense 26,050 13,958 87% 13,958 18,688 (25)% Net income attributable to common shareholders 74,201 38,661 92% 38,661 54,959 (30)% Earnings per share attributable to common shareholders (diluted)$ 23.34 $ 12.03 94%$ 12.03 $ 15.99 (25)% Operating profit margin 42 % 36 % NM 36 % 35 % NM Operating profit margin, as adjusted (a) 46 % 38 % NM 38 % 39 % NM (a) Net operating income, as adjusted, and operating profit margin, as adjusted, are non-GAAP (as defined below) performance measures. See Use of Supplemental Data as Non-GAAP Performance Measure section within this Annual Report on Form 10-K. Summary Discussion of Consolidated Results of Operations - Year EndedDecember 31, 2021 , compared with Year EndedDecember 31, 2020 Revenue for the year endedDecember 31, 2021 increased$55.8 million compared to the year endedDecember 31, 2020 , primarily due to a 38% increase in average AUM and$11.9 million in performance-based fees earned in 2021 compared to$0.5 million of performance-based fees in 2020. The increase was partially offset by a decrease in the average advisory fee rate (excluding performance-based fees) from 0.54% to 0.52% year-over-year. Operating profit margin was 42% for the year endedDecember 31, 2021 , and 36% for the year endedDecember 31, 2020 . Operating profit margin, as adjusted, was 46% for the year endedDecember 31, 2021 , and 38% for the year endedDecember 31, 2020 . Operating profit margin, as adjusted, excludes deferred compensation expense from operating income because it is offset by an equal amount in investment income below net operating income on the income statement and thus has no effect on net income attributable to the Company. We believe this measure based on methodologies other than GAAP ("non-GAAP") helps the reader to understand our core operating results and increases comparability period-to-period. See the "Use of Supplemental Data as Non-GAAP Performance Measures" section below in Part II. Item 7 of this Annual Report on Form 10-K.
The Company expects that its operating margin will fluctuate from period to period based on various factors, including revenues, investment results, employee performance, staffing levels, gains and losses on investments held in deferred compensation plans, and the development of investment strategies, products, or channels.
The Company recognized$16.4 million in investment income for the year endedDecember 31, 2021 , compared with investment income of$6.6 million for the year endedDecember 31, 2020 . The increase in investment income year-over-year was due to a higher average investment balance throughout the year and higher returns on the investments. The Company recorded a gain of$9.0 million related to the sale of our High Yield-Focused Advisory Contracts onJuly 30, 2021 . DHCM may receive two additional payments of up to$13.0 million in the aggregate based on the net revenue of the High Yield-Focused Advisory Contracts on the one-year anniversary of the Closing Date, but there can be no assurance these additional payments will be earned. 23 -------------------------------------------------------------------------------- Table of Contents Income tax expense increased$12.1 million for the year endedDecember 31, 2021 , compared to the year endedDecember 31, 2020 . The increase in income tax expense was primarily due to an increase in DHCM's income before taxes, which was partially offset by a decrease in our effective tax rate from 26.8% to 25.6% year-over-year. The decrease in the Company's effective tax rate in 2021 was primarily due to the benefit attributable to redeemable noncontrolling interests, and a decrease in excess tax deficits from the vesting of restricted stock, which were partially offset by an increase in state and local taxes from the performance fees year-over-year. The Company generated net income attributable to common shareholders of$74.2 million ($23.34 per diluted share) for the year endedDecember 31, 2021 , compared with net income attributable to common shareholders of$38.7 million ($12.03 per diluted share) for the year endedDecember 31, 2020 , primarily due to increased revenues, an increase in investment income, and the gain on the sale of the High Yield-Focused Advisory Contracts.
See the "Use of Supplemental Data as Non-GAAP Performance Measures" section below in Part II, Item 7, of this Annual Report on Form 10-K.
Summary Discussion of Consolidated Results of Operations - Year Ended
Revenue for the year endedDecember 31, 2020 , decreased$10.2 million compared to the year endedDecember 31, 2019 , primarily due to a decrease in the average advisory fee rate from 0.59% to 0.54% year-over-year, which was partially offset by a 1% increase in average AUM. The decrease in average advisory fee rate was driven by an increase in the mix of assets held in lower fee rate strategies. Operating profit margin was 36% for the year endedDecember 31, 2020 , and 35% for the year endedDecember 31, 2019 . Operating profit margin, as adjusted, was 38% for the year endedDecember 31, 2020 , and 39% for the year endedDecember 31, 2019 . Operating profit margin, as adjusted, excludes deferred compensation expense (benefit) from operating income because it is offset by an equal amount in investment income below net operating income on the income statement, and thus, has no effect on net income attributable to the Company. We believe this non-GAAP measure helps the reader to understand our core operating results and increases comparability period to period. See the "Use of Supplemental Data as Non-GAAP Performance Measures" section below in Part II. Item 7, of this Annual Report on Form 10-K.
The Company expects that its operating margin will fluctuate from period to period based on various factors, including revenues, investment results, employee performance, staffing levels, gains and losses on investments held in deferred compensation plans, and the development of investment strategies, products, or channels.
The Company recognized$6.6 million in investment income for the year endedDecember 31, 2020 , compared with investment income of$30.5 million for the year endedDecember 31, 2019 . The decrease in market appreciation year over year was due to a lower average investment balance throughout the year and lower returns on the investments. Income tax expense decreased$4.7 million for the year endedDecember 31, 2020 , compared to the year endedDecember 31, 2019 . The decrease in income tax expense was primarily due to a decrease in DHCM's income before taxes, which was partially offset by an increase in the Company's effective tax rate from 23.8% to 26.8% year-over-year. The increase in the effective tax rate in 2020 was primarily due to excess tax deficits on the vesting of restricted stock awards of$0.6 million in 2020 and the$1.0 million benefit attributable to redeemable noncontrolling interests in 2019. The Company generated net income attributable to common shareholders of$38.7 million ($12.03 per diluted share) for the year endedDecember 31, 2020 , compared with net income attributable to common shareholders of$55.0 million ($15.99 per diluted share) for the year endedDecember 31, 2019 , primarily due to decreased revenues and a decrease in investment income.
See the "Use of Supplemental Data as Non-GAAP Performance Measures" section below in Part II. Item 7, of this Annual Report on Form 10-K.
Revenue (in thousands, except percentages) 2021 2020 % Change 2020 2019 % Change Investment advisory$ 170,138 $ 119,125 43%$ 119,125 $ 128,009 (7)% Mutual fund administration, net 12,056 7,263 66% 7,263 8,615 (16)% Total$ 182,194 $ 126,388 44%$ 126,388 $ 136,624 (7)% 24
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Revenue for the Year Ended
Investment Advisory Fees. Investment advisory fees increased by$51.0 million , or 43%, from the year endedDecember 31, 2020 , to the year endedDecember 31, 2021 . Investment advisory fees are calculated as a percentage of the market value of client accounts at contractual fee rates, which vary by investment product. The increase in investment advisory fees was due to an increase of 38% in average AUM, and$11.9 million in performance-based fees recognized in 2021 as a significant performance-based agreement reached its first five-year measurement term. The Company recognized$0.5 million of performance-based fees in 2020. These increases were partially offset by a decrease in the average advisory fee rate (excluding performance-based fees) from 0.54% to 0.52% year-over-year. The decrease in average advisory fee rate was driven by an increase in the mix of assets held in lower fee rate strategies during the year endedDecember 31, 2021 , compared to the year endedDecember 31, 2020 . For the year endedDecember 31, 2021 , the average advisory fee rates for equity and fixed income strategies, excluding performance-based fees, were 0.54% and 0.39%, respectively. For the year endedDecember 31, 2020 , the average advisory fee rates for equity and fixed income strategies were 0.57% and 0.40%, respectively. Mutual Fund Administration Fees. Mutual fund administration fees increased$4.8 million , or 66%, from the year endedDecember 31, 2020 , to the year endedDecember 31, 2021 . Mutual fund administration fees include administration fees received from the Funds, which are calculated as a percentage of the Funds' average AUM. The increase was primarily due to a 36% increase in the Funds' average AUM from the year endedDecember 31, 2020 , to the year endedDecember 31, 2021 , and a reduction in administration fees paid on behalf of the Funds as a percentage of average Fund AUM year-over-year.
Revenue for the Year Ended
Investment Advisory Fees. Investment advisory fees decreased by$8.9 million , or 7%, from the year endedDecember 31, 2019 , to the year endedDecember 31, 2020 . Investment advisory fees are calculated as a percentage of the market value of client accounts at contractual fee rates, which vary by investment product. The decrease in investment advisory fees was driven by a reduction in the average advisory fee rate from 0.59% in 2019 to 0.54% in 2020, which was partially offset by an increase of 1% in average AUM year over year. The decrease in average advisory fee rate was driven by an increase in the mix of assets held in lower fee rate strategies during the year endedDecember 31, 2020 , compared to the year endedDecember 31, 2019 . For the year endedDecember 31, 2020 , the average advisory fee rates for equity and fixed income strategies were 0.57% and 0.40%, respectively. For the year endedDecember 31, 2019 , the average advisory fee rates for equity and fixed income strategies were 0.61% and 0.41%, respectively. Mutual Fund Administration Fees. Mutual fund administration fees decreased$1.4 million , or 16%, from the year endedDecember 31, 2019 , to the year endedDecember 31, 2020 . Mutual fund administration fees include administration fees received from the Funds, which are calculated as a percentage of the Funds' average AUM. The decrease was primarily due to an increase in sub-transfer agent and servicing fees paid by us on behalf of the Funds. In addition, there was a 1% decrease in the Funds' average AUM from the year endedDecember 31, 2019 , to the year endedDecember 31, 2020 .
Expenses
(in thousands, except percentages) 2021 2020 % Change 2020 2019 % Change Compensation and related costs, excluding deferred compensation expense$ 73,591 $ 58,292 26%$ 58,292 $ 60,264 (3)% Deferred compensation expense 7,082 2,219 219% 2,219 5,977 (63)% General and administrative 14,021 11,003 27% 11,003 13,278 (17)% Sales and marketing 7,659 6,000 28% 6,000 5,867 2% Mutual fund administration 3,582 3,336 7% 3,336 3,303 1% Total$ 105,935 $ 80,850 31%$ 80,850 $ 88,689 (9)%
Expenses for the Year Ended
Compensation and Related Costs, Excluding Deferred Compensation Expense.
Employee compensation and benefits increased by
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to increases in incentive compensation of$9.7 million , salary and related benefits of$3.1 million , restricted stock expense of$1.8 million , and other compensation expense of$0.7 million . On average, we had 126 full-time equivalent employees for both 2021 and 2020. Incentive compensation expense can fluctuate significantly period over period as we evaluate investment performance, individual performance, the Company's performance, and other factors. Deferred Compensation Expense. Deferred compensation expense was$7.1 million for the year endedDecember 31, 2021 , compared to deferred compensation expense of$2.2 million for the year endedDecember 31, 2020 , primarily due to an increase in market appreciation on our deferred compensation investments period over period. The gain on deferred compensation plan investments increases deferred compensation expense and is included in operating income. Deferred compensation expense is offset by an equal amount in investment income below net operating income on the consolidated statements of income statement, and thus has no impact on net income attributable to us. General and Administrative. General and administrative expenses increased by$3.0 million , or 27%, from the year endedDecember 31, 2020 , to the year endedDecember 31, 2021 . This increase was partially due a non-recurring$1.1 million refund related toOhio commercial activity tax, which was received in 2020 and reduced general and administrative expense. TheOhio commercial activity tax is a gross receipts tax, and therefore, is not included in income taxes. Other increases in 2021 include$0.7 million in consulting fees,$0.5 million of proxy solicitation fees related to the sale of the High Yield-Focused Advisory Contracts, a$0.4 million increase in IT staffing, hardware, and software expense, and a$0.3 million increase in depreciation expense. Sales and Marketing. Sales and marketing expenses increased by$1.7 million , or 28%, from the year endedDecember 31, 2020 , to the year endedDecember 31, 2021 . The increase was primarily due to increases of$0.7 million related to the Company's distribution technology platform and the related external data costs,$0.5 million for payments made to third-party intermediaries related to the sale of our mutual funds on their platforms, and a$0.5 million increase in advertising expenses.Mutual Fund Administration . Mutual fund administration expenses increased by 7% from the year endedDecember 31, 2020 , to the year endedDecember 31, 2021 . Mutual fund administration expense consists of both variable and fixed expenses. The variable expenses are based on Fund AUM levels and the number of shareholder accounts. The increase was due to an increase in variable expenses as a result of the increase in the average Fund AUM period-over-period.
Expenses for the Year Ended
Compensation and Related Costs, Excluding Deferred Compensation Expense. Employee compensation and benefits decreased by$2.0 million from the year endedDecember 31, 2019 , to the year endedDecember 31, 2020 . This decrease is primarily due to decreases in severance expense of$1.6 million and in restricted stock expense of$1.0 million . These decreases were partially offset by increases in salary and related benefits of$0.2 million and in incentive compensation of$0.4 million . On average, we had 126 full-time equivalent employees for 2020, compared to 128 for 2019. Incentive compensation expense can fluctuate significantly period over period as we evaluate investment performance, individual performance, the Company's performance, and other factors. Deferred Compensation Expense. Deferred compensation expense was$2.2 million for the year endedDecember 31, 2020 , compared to deferred compensation expense of$6.0 million for the year endedDecember 31, 2019 , mostly due to a decrease in market appreciation on our deferred compensation investments period over period. The gain on deferred compensation plan investments increases deferred compensation expense and is included in operating income. Deferred compensation expense is offset by an equal amount in investment income below net operating income on the consolidated statements of income statement, and thus has no impact on net income attributable to us. General and Administrative. General and administrative expenses decreased by$2.3 million , or 17%, from the year endedDecember 31, 2019 , to the year endedDecember 31, 2020 . This decrease was primarily due a non-recurring$1.1 million refund received in 2020 related to ourOhio commercial activity tax, which is a gross receipts tax, and therefore, is not included in income taxes, as well as decreases in corporate recruiting fees of$0.8 million , and in travel and related expenses period over period. Sales and Marketing. Sales and marketing expenses increased by$0.1 million , or 2%, from the year endedDecember 31, 2019 , to the year endedDecember 31, 2020 . The increase was primarily due to an increase in spending related to our customer relationship management system and related external data costs of$0.9 million . This increase was largely offset by a reduction in sales and marketing travel and related expense of$0.8 million . 26 -------------------------------------------------------------------------------- Table of ContentsMutual Fund Administration . Mutual fund administration expenses increased by 1% from the year endedDecember 31, 2019 , to the year endedDecember 31, 2020 . Mutual fund administration expense consists of both variable and fixed expenses. The variable expenses are based on Fund AUM levels and the number of shareholder accounts.
Liquidity and Capital Resources
Sources of Liquidity
The Company's current financial condition is liquid, with a significant amount of its assets comprised of cash and cash equivalents, investments, accounts receivable, and other current assets. The Company's main source of liquidity is cash flows from operating activities, which are generated from investment advisory and mutual fund administration fees. Cash and cash equivalents, investments held directly by DHCM, accounts receivable, and other current assets represented$214.7 million and$205.1 million of total assets as ofDecember 31, 2021 , and 2020, respectively. The Company believes that these sources of liquidity, as well as its continuing cash flows from operating activities, will be sufficient to meet its current and future operating needs for the next 12 months. Uses of Liquidity The Company anticipates that its main uses of cash will be for operating expenses and seed capital to fund new and existing investment strategies. The Board and management regularly review various factors to determine whether the Company has capital in excess of that required for its business, and the appropriate uses of any such excess capital.
Share Repurchases
OnFebruary 27, 2020 , the Board approved a stock repurchase program (the "2020 Repurchase Program") authorizing management to repurchase up to an additional$50 million of the Company's common shares. Under the 2020 Repurchase Program, the Company repurchased 45,727 of its common shares during the year endedDecember 31, 2021 , for a total of$7.8 million . As ofDecember 31, 2021 ,$27.6 million remains available for repurchases under the 2020 Repurchase Program. The authority to repurchase shares: (1) may be exercised from time to time as market conditions warrant, (2) is subject to regulatory constraints, and (3) will expire two years from the date of Board approval or upon the earlier repurchase in full of the authorized amount of shares. The timing, amount, and other terms and conditions of any repurchases will be determined by Company management in its discretion based on a variety of factors, including the market price of such shares, corporate considerations, general market and economic conditions, and applicable legal requirements.
The following table summarizes the quarterly repurchase transactions made under the 2020 Repurchase Program since its inception:
Total Number Average Price Purchase Price
of Shares Paid Per Share of Shares
Period Purchased Purchased Purchased
Quarter Ended March 31, 2020 48,576 $ 106.22 $ 5,159,919
Quarter Ended June 30, 2020 27,078 103.48 2,801,897
Quarter Ended September 30, 2020 53,735 123.99 6,662,508
Quarter Ended December 31, 2020 - - -
Quarter Ended March 31, 2021 12,529 151.1 1,893,146
Quarter Ended June 30, 2021 230 154.37 35,505
Quarter Ended September 30, 2021 31,468 $ 178.44 5,615,250
Quarter Ended December 31, 2021 1,500 184.28 276,414
Total 175,116 $ 128.17 $ 22,444,639
The 2020 Repurchase Program expired on February 25, 2022 , when our Board
approved the 2022 Repurchase Program. The 2022 Repurchase Program authorizes
management to repurchase up to $50.0 million of our common shares in the open
market and in private transactions in accordance with applicable securities
laws. The 2022 Repurchase Program will expire in February 2024 , or upon the
earlier completion of all authorized purchases under such program.
Dividends
Fiscal 2021 was the 14th consecutive year that the Company paid a dividend. The Company paid total dividends per share of$23.00 ,$12.00 , and$9.00 during the years endedDecember 31, 2021 , 2020, and 2019, respectively. The 2021, 2020, and 2019 dividends reduced shareholders' equity by$73.0 million ,$38.0 million , and$30.3 million , respectively. 27
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A summary of cash dividends paid during the year endedDecember 31, 2021 is presented below: Dividend Amount Dividend Declaration Date Date Paid (in millions) First quarter -$1.00 per share February 25, 2021 March 19, 2021 $ 3.1 Second quarter -$1.00 per share April 26, 2021 June 18, 2021 3.2 Third quarter -$1.00 per share July 28, 2021 September 24, 2021 3.2 Fourth quarter -$1.00 per share October 26, 2021 December 10, 2021 3.2 Fourth quarter -$19.00 per share - special dividend October 26, 2021 December 10, 2021 60.3 Total $ 73.0 OnFebruary 25, 2022 , the Board approved a regular quarterly dividend for the first quarter of 2022 of$1.50 per share to be paid onMarch 18, 2022 , to shareholders of record as ofMarch 7, 2022 . This dividend is expected to reduce shareholders' equity by approximately$4.8 million . Subject to Board approval and compliance with applicable law, the Company expects to pay a regular quarterly dividend of$1.50 per share going forward. In addition to the regular quarterly dividends, the Board will decide whether to approve and pay an additional special dividend in the fourth quarter of each fiscal year. Although the Company currently expects to continue to pay regular quarterly dividends, depending on the circumstances and the Board's judgment, the Company may not pay such dividends as described.
Working Capital
As ofDecember 31, 2021 , the Company had working capital of approximately$168.5 million , compared to$168.9 million as ofDecember 31, 2020 . Working capital includes cash and cash equivalents, accounts receivable, investments, and other current assets of DHCM, net of accounts payable and accrued expenses, accrued incentive compensation, deferred compensation, and other current liabilities of DHCM.
The Company had no debt and the Company believes its available working capital is sufficient to cover current expenses and presently anticipated capital expenditures.
Below is a summary of investments as of
As of December 31,
2021 2020
Corporate Investments:
Diamond Hill Core Bond Fund $ 46,755,404 $ 47,204,636
Diamond Hill International Fund 41,673,154 10,156,320
Diamond Hill Large Cap Concentrated Fund 12,098,049 - Diamond Hill Micro Cap Fund, LP 10,703,473 - Diamond Hill Long-Short Fund - 16,945,863 Diamond Hill Global Fund(a) - 11,269,719 Total Corporate Investments 111,230,080 85,576,538
Deferred Compensation Plan Investments in the Funds 37,348,294
33,241,952
Total investments held by DHCM 148,578,374
118,818,490
Redeemable noncontrolling interest in Consolidated Funds 18,077,627 9,582,646 Total investments$ 166,656,001 $ 128,401,136
(a)
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Cash Flow Analysis
Cash Flows from Operating Activities
The Company's cash flows from operating activities are calculated by adjusting net income to reflect other significant operating sources and uses of cash, certain significant non-cash items (such as share-based compensation), and timing differences in the cash settlement of operating assets and liabilities. The Company expects that cash flows provided by operating activities will continue to serve as its primary source of working capital in the near future. For the year endedDecember 31, 2021 , net cash provided by operating activities totaled$26.3 million . Cash provided by operating activities was primarily driven by net income of$75.6 million , the add back of share-based compensation of$7.4 million , depreciation of$1.3 million , and the cash impact of timing differences in the settlement of assets and liabilities of$12.3 million . These cash inflows were partially offset by net securities purchased by theDiamond Hill International Fund and theDiamond Hill Large Cap Concentrated Fund (together, the "Consolidated Funds") of$50.4 million , net gains on investments of$10.9 million , and the adjustment to net income of$9.0 million for the gain on sale of the High Yield-Focused Advisory Contracts. Absent the cash used in operations by the Consolidated Funds, cash flows provided by operations were$78.5 million . For the year endedDecember 31, 2020 , net cash provided by operating activities totaled$59.8 million . Cash provided by operating activities was primarily driven by net income of$38.2 million , the add back of share-based compensation of$7.7 million , depreciation of$1.0 million , net securities redeemed by the Consolidated Funds of$3.2 million , and the cash impact of timing differences in the settlement of assets and liabilities of$12.7 million . These cash inflows were partially offset by net gains on investments of$3.0 million . Absent the operating cash flows of the Consolidated Funds, cash flows from operations would have been approximately$57.3 million . For the year endedDecember 31, 2019 , net cash provided by operating activities totaled$57.0 million . Cash provided by operating activities was primarily driven by net income of$59.8 million , the add back of share-based compensation of$9.1 million , depreciation of$1.2 million , net securities redeemed by the Consolidated Funds of$6.3 million , and the cash impact of timing differences in the settlement of assets and liabilities of$1.7 million . These cash inflows were partially offset by net gains on investments of$21.1 million . Absent the operating cash flows of the Consolidated Funds, cash flow from operations would have been approximately$53.5 million .
Cash Flows from Investing Activities
The Company's cash flows from investing activities consist primarily of capital expenditures and purchases and redemptions in our investment portfolio. Cash flows provided by investing activities totaled$27.3 million for the year endedDecember 31, 2021 . The cash provided was primarily due to proceeds from investment redemptions totaling$40.8 million and$9.0 million of proceeds received from the sale of the High Yield-Focused Advisory Contracts. These proceeds were partially offset by corporate investment purchases of$21.4 million and property and equipment purchases (primarily capitalized software) of$1.1 million . Cash flows provided by investing activities totaled$8.4 million for the year endedDecember 31, 2020 . The cash provided was primarily due to proceeds from investment redemptions totaling$25.7 million . These proceeds were partially offset by corporate investment purchases of$14.9 million and property and equipment purchases (primarily capitalized software) of$2.5 million . Cash flows provided by investing activities totaled$10.9 million for the year endedDecember 31, 2019 . The cash provided was primarily due to proceeds from investment redemptions totaling$48.6 million . These proceeds were partially offset by corporate investment purchases of$14.4 million and property and equipment purchases of$0.7 million . The remaining change in reported cash flows from investing activities was attributable to$22.7 million in net cash that was removed from the Company's balance sheet due to the de-consolidation of our investment in an ETF during the period.
Cash Flows from Financing Activities
The Company's cash flows from financing activities consist primarily of repurchases of its common stock, shares withheld related to employee tax withholding, dividends paid on its common stock, proceeds received under theDiamond Hill Investment Group, Inc. Employee Stock Purchase Plan ("ESPP"), and distributions to, or contributions from, redeemable noncontrolling interest holders. 29
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For the year endedDecember 31, 2021 , net cash used in financing activities totaled$71.5 million , consisting of the payment of dividends of$73.0 million , repurchases of the Company's common stock of$7.8 million , and$1.6 million of shares withheld related to employee tax withholding. These cash outflows were partially offset by net subscriptions received in the Consolidated Funds from redeemable non-controlling interest holders of$10.3 million and proceeds received under the ESPP of$0.6 million . For the year endedDecember 31, 2020 , net cash used in financing activities totaled$62.9 million , consisting of the payment of special dividends of$38.0 million , repurchases of our common stock of$18.7 million ,$1.9 million of shares withheld related to employee tax withholding, and net redemptions in the Consolidated Funds from redeemable non-controlling interest holders of$4.3 million . For the year endedDecember 31, 2019 , net cash used in financing activities totaled$59.1 million , consisting of the payment of special dividends of$30.3 million , repurchases of our common stock of$38.7 million , and$1.4 million of shares withheld related to employee tax withholding. These financing outflows were partially offset by net subscriptions received in the Consolidated Funds from redeemable non-controlling interest holders of$11.3 million .
Supplemental Consolidated Cash Flow Statement
The following table summarizes the condensed cash flows for the years endedDecember 31, 2021 , 2020, and 2019 that are attributable to the Company and to the Consolidated Funds, and the related eliminations required in preparing the consolidated financial statements. Year Ended December 31, 2021 Cash flow attributable to Cash flow As reported on the Diamond Hill attributable to Consolidated Investment Group, Consolidated Statement of Cash Inc. Funds Eliminations Flows Cash flows from operating activities: Net income$ 74,200,609 $ 5,851,988 $ (4,463,058) $ 75,589,539 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 1,281,420 - - 1,281,420 Share-based compensation 7,415,170 - - 7,415,170 Gain on sale of high yield-focused advisory contracts (9,000,000) - - (9,000,000) Net gains on investments (7,599,548) (5,851,988) 2,572,878 (10,878,658) Net change in securities held by Consolidated Funds - (50,430,607) - (50,430,607) Other changes in assets and liabilities 12,209,848 125,525 - 12,335,373 Net cash provided by (used in) operating activities 78,507,499 (50,305,082) (1,890,180) 26,312,237 Net cash provided by (used in) investing activities (14,631,872) - 41,896,371 27,264,499 Net cash provided by (used in) financing activities (81,803,436) 50,305,082 (40,006,191) (71,504,545) Net change during the year (17,927,809) - - (17,927,809) Cash and cash equivalents at beginning of year 98,478,202 - - 98,478,202
Cash and cash equivalents at end of year
- $ -
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Year Ended December 31, 2020
Cash flow
attributable to As reported on the
Diamond Hill Cash flow Consolidated
Investment Group, attributable to Statement of Cash
Inc. Consolidated Funds Eliminations Flows
Cash flows from Operating Activities:
Net Income $ 38,660,545 $ 403,985 $ (899,392) $ 38,165,138
Adjustments to reconcile net income to
net cash provided by operating
activities:
Depreciation 992,836 - - 992,836
Share-based compensation 7,739,320 - - 7,739,320
Net gains on investments (3,500,848) (403,985) 899,392 (3,005,441)
Net change in securities held by
Consolidated Funds - 3,179,362 - 3,179,362
Other changes in assets and liabilities 13,394,030 (692,760) - 12,701,270
Net cash provided by operating
activities 57,285,883 2,486,602 - 59,772,485
Net cash provided by investing
activities 6,587,218 - 1,824,482 8,411,700
Net cash used in financing activities (58,571,152) (2,486,602) (1,824,482) (62,882,236)
Net change during the year 5,301,949 - - 5,301,949
Cash and cash equivalents at beginning
of year 93,176,253 - - 93,176,253
Cash and cash equivalents at end of
year $ 98,478,202 $ - $ - $ 98,478,202 Year Ended
Cash flow
attributable to As reported on the
Diamond Hill Cash flow Consolidated
Investment Group, attributable to Statement of Cash
Inc. Consolidated Funds Eliminations Flows
Cash flows from Operating Activities:
Net Income $ 54,959,024 $ 12,108,850 $ (7,313,555) $ 59,754,319
Adjustments to reconcile net income to
net cash provided by operating
activities:
Depreciation 1,164,207 - - 1,164,207
Share-based compensation 9,081,421 - - 9,081,421
Net gains on investments (16,263,168) (12,108,850) 7,313,555 (21,058,463)
Net change in securities held by
Consolidated Funds - 6,286,645 - 6,286,645
Other changes in assets and liabilities 4,518,254 (2,780,140) - 1,738,114
Net cash provided by operating
activities 53,459,738 3,506,505 - 56,966,243
Net cash provided by (used in)
investing activities 25,702,461 (22,723,853) 7,876,466 10,855,074
Net cash provided by (used in)
financing activities (70,416,005) 19,217,348 (7,876,466) (59,075,123)
Net change during the year 8,746,194 - - 8,746,194
Cash and cash equivalents at beginning
of year 84,430,059 - - 84,430,059
Cash and cash equivalents at end of
year $ 93,176,253 $ - $ - $ 93,176,253
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Contractual Obligations
The following table presents a summary of the Company's future obligations under the terms of lease commitments, contractual purchase obligations, and deferred compensation obligations as ofDecember 31, 2021 . Other purchase obligations include contractual amounts that will be due for the purchase of services to be used in the Company's operations, such as mutual fund sub-administration, sales data costs, and investment related research software. These obligations may be cancellable at earlier times than those indicated and, under certain circumstances, may involve termination fees. Because these obligations are primarily of a normal recurring nature, the Company expects to fund them from future cash flows from operations. Deferred compensation obligations include compensation that will be paid out in future years and which will be funded by the related deferred compensation investments currently held on the Company's consolidated balance sheets (see Note 7 to the consolidated financial statements). The information presented does not include operating expenses or capital expenditures that will be committed in the normal course of operations in 2022 and future years: Payments Due by Period Total 2022 2023 2024 2025 2026 Thereafter
Operating lease obligations
$ 624,179 $ 624,179 $ 156,044 $ - $ - Purchase obligations 7,099,679 3,960,575 1,670,814 709,138 706,027 53,125 - Deferred compensation obligations 37,348,294 3,474,351 3,911,526 4,288,132 4,942,954 2,262,332 18,468,999 Total$ 46,476,554 $ 8,059,105 $ 6,206,519 $ 5,621,449 $ 5,805,025 $ 2,315,457 $ 18,468,999
Use of Supplemental Data as Non-GAAP Performance Measures
As supplemental information, the Company is providing performance measures that are based on non-GAAP methodologies. The Company believes that the non-GAAP measures below are useful measures of its core business activities, are important metrics in estimating the value of an asset management business, and may enable more appropriate comparisons to its peers. These non-GAAP measures should not be used as a substitute for financial measures calculated in accordance with GAAP and may be calculated differently by other companies. The following schedule reconciles GAAP measures to non-GAAP measures for the years endedDecember 31, 2021 , 2020, and 2019, respectively. Year Ended December 31, (in thousands, except percentages and per share data) 2021 2020 2019 Total revenue$ 182,194
Net operating income, GAAP basis$ 76,258 $ 45,538 $ 47,935 Non-GAAP adjustments: Gains on deferred compensation plan investments, net(1) 7,082 2,219 5,977 Net operating income, as adjusted, non-GAAP basis(2) 83,340 47,757 53,912
Non-GAAP adjustments: Tax provision on net operating income, as adjusted, non-GAAP basis(3)
(21,656) (12,668) (13,680)
Net operating income, as adjusted, after tax, non-GAAP basis(4)
Net operating income, as adjusted after tax per diluted share, non-GAAP basis(5)
$ 19.40 $ 10.91 $ 11.71 Diluted weighted average shares outstanding, GAAP basis 3,179 3,215 3,437 Operating profit margin, GAAP basis 42 % 36 % 35 % Operating profit margin, as adjusted, non-GAAP basis(6) 46 % 38 % 39 % (1) Gains on deferred compensation plan investments, net: The gain on deferred compensation plan investments, which increases deferred compensation expense included in operating income, is removed from operating income in the calculation because it is offset by an equal amount in investment income below net operating income on the income statement, and thus has no impact on net income attributable to the Company. 32
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(2) Net operating income, as adjusted: This non-GAAP measure represents the Company's net operating income adjusted to exclude the impact on compensation expense of gains and losses on investments in the deferred compensation plan.
(3) Tax provision on net operating income, as adjusted: This non-GAAP measure represents the tax provision, excluding the impact of investment related activity, and the gain on sale of High Yield-Focused Advisory Contracts, and is calculated by applying the unconsolidated effective tax rate to net operating income, as adjusted. (4) Net operating income, as adjusted, after tax: This non-GAAP measure deducts from the net operating income, as adjusted, the tax provision on net operating income, as adjusted. (5) Net operating income, as adjusted after tax per diluted share: This non-GAAP measure was calculated by dividing the net operating income, as adjusted after tax, by diluted weighted average shares outstanding.
(6) Operating profit margin, as adjusted: This non-GAAP measure was calculated by dividing the net operating income, as adjusted, by total revenue.
Off-Balance Sheet Arrangements
The Company has no off-balance sheet arrangements. The Company does not have any obligation under a guarantee contract, a retained or contingent interest in assets, or any similar arrangement that serves as credit, liquidity, or market risk support for such assets, or any other obligation, including a contingent obligation, under a contract that would be accounted for as a derivative instrument or arising out of a variable interest.
Critical Accounting Policies and Estimates
Consolidation. The Company consolidates all subsidiaries and certain investments
in which the Company has a controlling interest. The Company is generally deemed
to have a controlling interest when it owns the majority of the voting interest
of a voting rights entity ("VRE") or are deemed to be the primary beneficiary of
a variable interest entity ("VIE"). A VIE is an entity that lacks sufficient
equity to finance its activities, or any entity whose equity holders do not have
defined power to direct the activities of the entity normally associated with an
equity investment. The Company's analysis to determine whether an entity is a
VIE or a VRE involves judgment and considers several factors, including an
entity's legal organization, equity structure, the rights of the investment
holders, our ownership interest in the entity, and our contractual involvement
with the entity. The Company continually reviews and reconsiders its VIE or VRE
conclusions upon the occurrence of certain events, such as changes to its
ownership interest, or amendments to contract documents.
Provisions for Income Taxes. The objectives of accounting for income taxes are
to recognize the amount of taxes payable or refundable for the current year and
deferred tax liabilities and assets for the future tax consequences of events
that have been recognized in an entity's financial statements or tax returns.
Judgment is required in assessing the future tax consequences of events that
have been recognized in our financial statements or tax returns.
Revenue Recognition on Performance-Based Advisory Contracts. The Company has
certain investment advisory contracts in which a portion of the fees are based
on investment performance achieved in the respective client portfolio in excess
of a specified hurdle rate. These fees are calculated based on client investment
results over rolling five-year periods. The Company record performance-based
fees at the end of the contract measurement period because the performance-based
fees earned are constrained based on movements in the financial markets.
Revenue Recognition when Acting as an Agent vs. Principal. 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 fund shareholder mailings,
registration services, 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 the Funds pay to DHCM is reviewed annually by the Funds'
board of trustees and specifically considers 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 expenses, as appropriate for this
agency relationship.
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