PZENA INVESTMENT MANAGEMENT, INC. Overview
We are an investment management firm that utilizes a classic value investment approach across all of our investment strategies. We currently manage assets in a variety of value-oriented investment strategies across a wide range of market capitalizations in bothU.S. and non-U.S. capital markets. AtSeptember 30, 2020 , our assets under management, or AUM, was$33.3 billion . We manage separate accounts on behalf of institutions, act as sub-investment adviser for a variety ofSEC -registered mutual funds and non-U.S. funds, and act as investment adviser for the Pzena mutual funds, private placement funds and non-U.S. funds. We function as the sole managing member of our operating company,Pzena Investment Management, LLC (the "operating company"). As a result, we: (i) consolidate the financial results of our operating company with our own, and reflect the membership interest in it that we do not own as a non-controlling interest in our consolidated financial statements; and (ii) recognize income generated from our economic interest in our operating company's net income. As ofSeptember 30, 2020 , the holders of our Class A common stock and the holders of Class B units of our operating company held approximately 23.7% and 76.3%, respectively, of the economic interests in theSeptember 30, 2020 value of our operating company. As ofSeptember 30, 2020 , the holders of our Class A common stock and the holders of Class B and Class B-1 units of our operating company held approximately 21.9%, 70.6%, and 7.5%, respectively, of the future income and distributions. The Company also serves as the general partner ofPzena Investment Management, LP , a partnership formed with the objective of aggregating employee ownership in one entity. Our founders and certain of our employees have interests inPzena Investment Management, LP and certain estate planning vehicles through which they indirectly own Class B and B-1 units of our operating company. As ofSeptember 30, 2020 , through direct and indirect interests, our three founders, 48 other employee members, and certain other members of our operating company, including one of our directors, his related entities, and certain former employees, collectively held 50.7%, 5.8%, and 19.8% of the economic interests in our operating company, respectively. As ofSeptember 30, 2020 , through direct and indirect interests, our three founders, 48 other employee members, and certain former employees, collectively held 46.9%, 12.9%, and 18.4% of the future income and distributions of our operating company.
Net Income
Diluted net income and diluted earnings per share were$12.4 million and$0.16 , respectively, for the three months endedSeptember 30, 2020 , and$13.8 million and$0.19 , respectively, for the three months endedSeptember 30, 2019 . Diluted net income and diluted earnings per share were$23.1 million and$0.28 , respectively, for the nine months endedSeptember 30, 2020 , and$39.8 million and$0.54 , respectively, for the nine months endedSeptember 30, 2019 . For the nine months endedSeptember 30, 2020 , the calculation of diluted earnings per share resulted in an increase in earnings per share. Therefore, diluted earnings per share is assumed to be equal to earnings per share. In evaluating our financial condition and results of operations, we also review non-GAAP measures of earnings, which are adjusted to exclude accounting adjustments related to our deferred tax asset generated by the Company's initial public offering and subsequent Class B unit conversions, as well as our tax receivable agreement and the associated liability to our selling and converting shareholders. No such adjustments were made to the GAAP results for the three and nine months endedSeptember 30, 2020 and 2019. Net income for diluted earnings per share generally assumes all operating company membership units are converted into Company stock at the beginning of the reporting period, and the resulting change to our net income associated with our increased interest in the operating company is taxed at our historical effective tax rate, exclusive of the adjustments related to changes in the valuation allowance recorded against the deferred tax asset and other discrete and permanently non-deductible items. Our effective tax rate was 24.3% and 25.0% for the three and nine months endedSeptember 30, 2020 , respectively, and 23.5% and 23.4% for the three and nine months endedSeptember 30, 2019 , respectively. See "Operating Results - Income Tax Expense" below.
Revenue
We generate revenue primarily from management fees and performance fees, which
we collectively refer to as our advisory fees, by managing assets on behalf of
our separately managed and sub-advised accounts, as well as our Pzena funds. Our
advisory fee income is primarily based on our AUM, as discussed below, and
recognized over the period in which investment
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management services are provided. In accordance with the Revenue Recognition
Topic of the Financial Accounting Standards Board Accounting Standards
Codification ("FASB ASC"), income from performance fees is recorded at the
conclusion of the contractual performance period, when it is probable that
significant reversal of the performance fee will not occur. Advisory fee income
also includes fund expense cap reimbursements which are required to be presented
net against revenue rather than as a component of general and administrative
expense.
Our advisory fees are primarily driven by the level of our AUM. Our AUM
increases or decreases with the net inflows or outflows of funds into our
various investment strategies and with the investment performance thereof. In
order to increase our AUM and expand our business, we must develop and market
investment strategies that suit the investment needs of our target clients, and
provide attractive returns over the long term. The value and composition of our
AUM, and our ability to continue to attract clients depends on a variety of
factors as described in "Item 1 - Risk Factors - Risks Related to Our Business -
Our primary source of revenue is derived from management fees, which are
directly tied to the levels of our assets under management. Fluctuations in AUM
therefore will directly impact our revenue" of our Annual Report on Form 10-K
for the year ended December 31, 2019 .
For our separately managed accounts, we are paid fees according to a schedule,
which varies by investment strategy. The substantial majority of these accounts
pay us management fees pursuant to a schedule by which the rate we earn on the
AUM declines as the amount of AUM increases.
Pursuant to our sub-investment advisory agreements, we are generally paid a management fee according to a schedule in which the rate we earn on the AUM declines as the amount of AUM increases. Certain of these funds pay us fixed-rate management fees. Due to the substantially larger account size of certain of these accounts, the average advisory fees we earn on them, as a percentage of AUM, are lower than the advisory fees we earn on our separately managed accounts.
Advisory fees we earn on separately managed accounts are generally based on the value of AUM at a specific date on a quarterly basis. Certain of our separately managed accounts, and all of our sub-advised accounts, are calculated based on the average of the monthly or daily market value. Advisory fees are also generally adjusted for any cash flows into or out of a portfolio, where the cash flow represents greater than 10% of the value of the portfolio. While a specific group of accounts may use the same fee rate, the calculation methodology may differ as described above. Certain of our clients pay us performance fees according to the performance of their accounts relative to certain agreed-upon benchmarks, which results in a lower base fee, but allows for us to earn higher fees if the relevant investment strategy outperforms the agreed-upon benchmark. Some performance-based fee arrangements include high-water mark provisions, which generally provide that if a client account underperforms relative to its performance target, it must gain back such underperformance before we can collect future performance-based fees. Fulcrum fee arrangements require a reduction in the base fee, or allow for a performance fee if the relevant investment strategy underperforms or outperforms, respectively, the agreed-upon benchmark.
Our advisory fees may fluctuate based on a number of factors, including the following:
• changes in AUM due to appreciation or depreciation of our investment
portfolios, and the levels of the contribution and withdrawal of assets by
new and existing clients;
• distribution of AUM among our investment strategies, which have differing
fee schedules;
• distribution of AUM between separately managed accounts and sub-advised
accounts, for which we generally earn lower overall advisory fees; and
• the level of our performance with respect to accounts on which we are paid
performance fees or have fulcrum fee arrangements.
Expenses
Our expenses consist primarily of Compensation and Benefits Expense, as well as
General and Administrative Expense. Our largest expense is Compensation and
Benefits, which includes the salaries, bonuses, equity-based compensation, and
related benefits and payroll costs attributable to our employee members and
employees. Compensation and benefits packages are benchmarked against relevant
industry and geographic peer groups in order to attract and retain qualified
personnel. General and Administrative Expense includes lease expenses,
professional and outside services fees, depreciation,
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the costs associated with operating and maintaining our research, trading and portfolio accounting systems, the costs associated with being a public company, and other expenses. Our occupancy-related costs and professional services expenses, in particular, generally increase or decrease in relative proportion to the overall size and scale of our business operations.
Our expenses may fluctuate due to a number of factors, including the following:
• variations in the level of total compensation expense due to, among other
things, bonuses, awards of equity to our employees and employee members of
our operating company, changes in our employee count and mix, and
competitive factors; and
• general and administrative expenses, such as rent, professional service fees
and data-related costs, incurred, as necessary, to run our business.
Other Income/ (Expense)
Other Income/ (Expense) is derived primarily from investment income or loss arising from our consolidated subsidiaries, income or loss generated by our investments, and interest income generated on our cash balances. Other Income/ (Expense) is also affected by changes in our estimates of the liability due to our selling and converting shareholders associated with payments owed to them under the tax receivable agreement, which was executed in connection with our reorganization and initial public offering onOctober 30, 2007 . As discussed further below under "Tax Receivable Agreement," this liability represents 85% of the amount of cash savings, if any, inU.S. federal, state, and local income tax that we realize as a result of the amortization of the increases in tax basis generated from our acquisitions of our operating company's units from our selling and converting shareholders. We expect the interest and investment components of Other Income/ (Expense), in the aggregate, to fluctuate based on market conditions and the performance of our consolidated entities and other investments. Non-Controlling Interests We are the sole managing member of our operating company and control its business and affairs and, therefore, consolidate its financial results with ours. In light of our employees' and outside investors' direct and indirect interests in our operating company, we have reflected their membership interests as non-controlling interest in our consolidated financial statements. As ofSeptember 30, 2020 , the holders of Class A common stock of the Company and the holders of Class B units of the operating company held approximately 23.7% and 76.3%, respectively, of the economic interests in the operations of the business. In addition, our operating company consolidates the results of operations of the private investment partnerships over which we exercise a controlling influence. Non-controlling interests recorded in our consolidated financial statements include the non-controlling interests of the outside investors in these consolidated subsidiaries.
Operating Results
General
Our earnings and cash flows are heavily dependent upon prevailing financial market conditions. Significant increases or decreases in the various securities markets, particularly equities markets, can have a material impact on our results of operations, financial condition and cash flows.
The global effects of COVID-19 on the securities market caused a significant reduction in our AUM fromDecember 31, 2019 . Because the revenue we earn is based on our AUM, we expect this and any further decline in our AUM to result in a corresponding decline in our revenues and earnings. The future impact of the COVID-19 pandemic and governmental responses to the pandemic remain uncertain. Therefore, although we expect the effects of COVID-19 to continue to have an impact on our results of operations, the magnitude of such impact cannot be determined and are subject to a number of uncertainties. We continue to plan for and assess our ability to respond to these uncertainties, including the duration and severity of the pandemic, the impact of the pandemic and government stimulus actions on the economy and the financial markets and the continued ability of us and our clients to maintain current operations without disruption while working remotely. 29
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Assets Under Management and Flows
As ofSeptember 30, 2020 and 2019, our AUM of approximately$33.3 billion and$35.8 billion , respectively, was invested in a variety of value-oriented investment strategies, representing distinct market capitalization segments ofU.S. and non-U.S. equity markets. The assets under management and performance of our largest investment strategies as ofSeptember 30, 2020 are further described below. We follow the same investment process for each of these strategies. Our investment strategies are distinguished by the market capitalization ranges from which we select securities for their portfolios, which we refer to as each strategy's investment universe, as well as the regions in which we invest and the degree to which we concentrate on a limited number of holdings. While our investment process includes ongoing review of companies in the investment universes described below, our actual investments may include companies outside of the relevant market capitalization range at the time of our investment. In addition, the number of holdings typically found in the portfolios of each of our investment strategies may vary, as described below. The following tables describe the allocation of our AUM among our investment strategies and the domicile of our accounts, as ofSeptember 30, 2020 and 2019: AUM at September 30, Strategy 2020 2019 (in billions)U.S. Value Strategies Large Cap Value$ 7.2 $ 9.4 Mid Cap Value 2.3 2.6 Small Cap Value 1.4 1.3 Value 0.4 0.9 Other U.S. Strategies 0.2 0.2 Total U.S. Value Strategies 11.5 14.4 Global and Non-U.S. Value Strategies Global Value 8.4 7.7 International Value 5.9 6.2 Emerging Markets Value 5.1 4.5 European Value 2.1 2.6 Other Global and Non-U.S. Strategies 0.3 0.4 Total Global and Non-U.S. Value Strategies 21.8 21.4 Total$ 33.3 $ 35.8 AUM at September 30, Account Domicile 2020 2019 (in billions) U.S.$ 21.1 $ 23.6 Non-U.S. 12.2 12.2 Total$ 33.3 $ 35.8 30
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The following table indicates the annualized returns, gross and net (which represents annualized returns prior to, and after, payment of advisory fees, respectively), of our largest investment strategies from their inception toSeptember 30, 2020 , and in the five-year, three-year, and one-year periods endedSeptember 30, 2020 , as well as the performance of the market index which is most commonly used by our clients to compare the performance of the relevant investment strategy. Period Ended September 30, 20201 Investment Strategy (Inception Since Date) Inception 5 Years 3 Years 1 Year Large Cap Value (July 2012 ) Annualized Gross Returns 8.3 % 4.4 % -4.0 % -16.4 % Annualized Net Returns 8.1 % 4.3 % -4.1 % -16.5 % Russell 1000® Value Index 9.7 % 7.7 % 2.6 % -5.0 % International Value (November 2008) Annualized Gross Returns 7.7 % 3.4 % -3.2 % -4.8 % Annualized Net Returns 7.4 % 3.1 % -3.5 % -5.2 % MSCI EAFE® Index-Net/U.S.$2 6.4 % 5.3 % 0.6 % 0.5 % Global Value (January 2010 ) Annualized Gross Returns 5.8 % 3.9 % -3.5 % -10.6 % Annualized Net Returns 5.5 % 3.6 % -3.9 % -10.9 % MSCI® World Index - Net/U.S.$2 9.0 % 10.5 % 7.7 % 10.4 % Emerging Markets Focused Value (January 2008) Annualized Gross Returns 2.0 % 7.0 % -3.0 % -5.3 % Annualized Net Returns 1.2 % 6.2 % -3.8 % -6.0 % MSCI® Emerging Markets Index-Net/U.S.$2 1.3 % 9.0 % 2.4 % 10.5 % Large Cap Focused Value (October 2000) Annualized Gross Returns 5.5 % 3.4 % -6.2 % -19.9 % Annualized Net Returns 5.0 % 3.0 % -6.5 % -20.2 % Russell 1000® Value Index 6.2 % 7.7 % 2.6 % -5.0 % European Focused Value (August 2008) Annualized Gross Returns 2.5 % -0.1 % -8.9 % -13.8 % Annualized Net Returns 2.1 % -0.4 % -9.3 % -14.1 % MSCI® Europe Index - Net/U.S.$2 2.1 % 4.2 % -0.6 % -0.8 % Global Focused Value (January 2004) Annualized Gross Returns 4.1 % 3.2 % -5.0 % -13.0 % Annualized Net Returns 3.4 % 2.6 % -5.6 % -13.5 % MSCI® All Country World Index - Net/U.S.$2 7.1 % 10.3 % 7.1 % 10.4 % Mid Cap Value (April 2014 ) Annualized Gross Returns 2.3 % 3.3 % -6.1 % -15.1 % Annualized Net Returns 2.1 % 3.1 % -6.3 % -15.3 % Russell Mid Cap® Value Index 5.0 % 6.4 % 0.8 % -7.3 % Small Cap Focused Value (January 1996) Annualized Gross Returns 11.4 % 3.2 % -6.8 % -16.6 % Annualized Net Returns 10.3 % 2.2 % -7.7 % -17.4 % Russell 2000® Value Index 8.2 % 4.1 % -5.1 % -14.9 % Focused Value (January 1996 ) Annualized Gross Returns 8.8 % 2.8 % -7.1 % -19.2 % Annualized Net Returns 8.0 % 2.2 % -7.6 % -19.7 % Russell 1000® Value Index 8.2 % 7.7 % 2.6 % -5.0 % International Focused Value (January 2004) Annualized Gross Returns 5.0 % 3.6 % -3.8 % -6.4 % Annualized Net Returns 4.3 % 3.1 % -4.3 % -6.9 % MSCI®All Country World ex-U.S. Index - Net/U.S.$2 5.5 % 6.2 % 1.2 % 3.0 % Mid Cap Focused Value (September 1998) Annualized Gross Returns 10.6 % 4.3 % -5.0 % -12.9 % Annualized Net Returns 9.9 % 3.7 % -5.6 % -13.5 % Russell Mid Cap® Value Index 9.2 % 6.4 % 0.8 % -7.3 %
1 The historical returns of these investment strategies are not necessarily
indicative of their future performance, or the future performance of any of
our other current or future investment strategies.
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2 Net of applicable withholding taxes and presented in
Large Cap Value. This strategy reflects a portfolio composed of approximately 50 to 80 stocks drawn from a universe of 500 of the largestU.S. listed companies, based on market capitalization. This strategy was launched inJuly 2012 . AtSeptember 30, 2020 , the Large Cap Value strategy generated a one-year annualized gross return of -16.4%, underperforming its benchmark. The top detracting sectors were the consumer discretionary, financial services, and energy sectors International Value. This strategy reflects a portfolio composed of approximately 60 to 80 stocks drawn from a universe of 1,500 of the largest companies across the world excludingthe United States , based on market capitalization. This strategy was launched inNovember 2008 . AtSeptember 30, 2020 , the International Value strategy generated a one-year annualized gross return of -4.8%, underperforming its benchmark. The top detracting sectors were the energy, health care, and financial services sectors, partially offset by the performance of the industrials sector. Global Value. This strategy reflects a portfolio composed of approximately 60 to 95 stocks drawn from a universe of 2,000 of the largest companies across the world, based on market capitalization. This strategy was launched inJanuary 2010 . AtSeptember 30, 2020 , the Global Value strategy generated a one-year annualized gross return of -10.6%, underperforming its benchmark. The top detracting sectors included the information technology, financial services, and consumer discretionary sectors. Emerging Markets Focused Value. This strategy reflects a portfolio composed of approximately 40 to 80 stocks drawn from a universe of 1,500 of the largest emerging market companies, based on market capitalization. This strategy was launched inJanuary 2008 . AtSeptember 30, 2020 , the Emerging Markets Focused Value strategy generated a one-year annualized gross return of -5.3%, outperforming its benchmark. The top detracting sectors included the consumer discretionary, utilities, and financial services sectors, partially offset by the performance of the consumer staples sector. Large Cap Focused Value. This strategy reflects a portfolio composed of approximately 30 to 40 stocks drawn from a universe of 500 of the largestU.S. listed companies, based on market capitalization. This strategy was launched inOctober 2000 . AtSeptember 30, 2020 , the Large Cap Focused Value strategy generated a one-year annualized gross return of -19.9%, underperforming its benchmark. The top detracting sectors included the consumer discretionary, financial services, and energy sectors. European Focused Value. This strategy reflects a portfolio composed of approximately 40 to 50 stocks drawn from a universe of 750 of the largest European companies, based on market capitalization. This strategy was launched inAugust 2008 . AtSeptember 30, 2020 , the European Focused Value strategy generated a one-year annualized gross return of -13.8%, underperforming its benchmark. The top detracting sectors included the financial services, energy, and health care sectors. Global Focused Value. This strategy reflects a portfolio composed of approximately 40 to 60 stocks drawn from a universe of 2,000 of the largest companies across the world, based on market capitalization. This strategy was launched inJanuary 2004 . AtSeptember 30, 2020 , the Global Focused Value strategy generated a one-year annualized gross return of -13.0%, underperforming its benchmark. The top detracting sectors included the information technology, financial services, and consumer discretionary sectors.
Mid Cap Value. This strategy reflects a portfolio composed of approximately 50
to 80 stocks drawn from a universe of
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Small Cap Focused Value. This strategy reflects a portfolio composed of approximately 40 to 50 stocks drawn from a universe ofU.S. listed companies ranked from the 1,001st to 3,000th largest, based on market capitalization. This strategy was launched inJanuary 1996 . AtSeptember 30, 2020 , the Small Cap Focused Value strategy generated a one-year annualized gross return of -16.6%, underperforming its benchmark. The top detracting sectors included the health care, energy, and financial services sectors, partially offset by the performance of the real estate and industrials sectors. Focused Value. This strategy reflects a portfolio composed of a portfolio of approximately 30 to 40 stocks drawn from a universe of 1,000 of the largestU.S. listed companies, based on market capitalization. This strategy was launched inJanuary 1996 . AtSeptember 30, 2020 , the Focused Value strategy generated a one-year annualized gross return of -19.2%, underperforming its benchmark. The top detracting sectors included the consumer discretionary, health care, and technology sectors. International Focused Value. This strategy reflects a portfolio composed of approximately 30 to 50 stocks drawn from a universe of 1,500 of the largest companies across the world excludingthe United States , based on market capitalization. This strategy was launched inJanuary 2004 . AtSeptember 30, 2020 , the International Focused Value strategy generated a one-year annualized gross return of -6.4%, underperforming its benchmark. The top detracting sectors were the financial services, consumer discretionary, and energy sectors. Mid Cap Focused Value. This strategy reflects a portfolio composed of approximately 30 to 40 stocks drawn from a universe ofU.S. listed companies ranked from the 201st to 1,200th largest, based on market capitalization. This strategy was launched inSeptember 1998 . AtSeptember 30, 2020 , the Mid Cap Focused Value strategy generated a one-year annualized gross return of -12.9%, underperforming its benchmark. The top detracting sectors included the technology, energy, and health care sectors, partially offset by the performance of the real estate and financial services sectors. Our earnings and cash flows are heavily dependent upon prevailing financial market conditions. Significant increases or decreases in the various securities markets, particularly the equities markets, can have a material impact on our results of operations, financial condition, and cash flows. 33
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The change in AUM in our separately managed accounts, sub-advised accounts, and Pzena funds for the three and nine months endedSeptember 30, 2020 and 2019 is described below. Inflows are composed of the investment of new or additional assets by new or existing clients. Outflows consist of redemptions of assets by existing clients. Assets Under Management ($ billions) For the Three Months For the Nine Months Ended September 30, Ended September 30, 2020 2019 2020 2019 Separately Managed Accounts Assets Beginning of Period$ 13.0 $ 13.9 $ 16.4 $ 12.6 Inflows 0.2 0.4 1.2 1.8 Outflows (0.3 ) (0.3 ) (1.0 ) (1.7 ) Net Flows (0.1 ) 0.1 0.2 0.1 Market Appreciation/(Depreciation) 0.1 (0.3 ) (3.4 ) 1.0 Foreign Exchange1 0.3 - 0.1 - End of Period$ 13.3 $ 13.7 $ 13.3 $ 13.7 Sub-Advised Accounts Assets Beginning of Period$ 16.4 $ 21.1 $ 22.4 $ 18.8 Inflows 2.5 0.4 4.0 1.8 Outflows (1.2 ) (1.4 ) (3.4 ) (2.7 ) Net Flows 1.3 (1.0 ) 0.6 (0.9 ) Market Appreciation/(Depreciation) 0.2 (0.3 ) (5.1 ) 1.9 Foreign Exchange1 0.1 - 0.1 - End of Period$ 18.0 $ 19.8 $ 18.0 $ 19.8 Pzena Funds Assets Beginning of Period$ 2.1 $ 2.3 $ 2.4 $ 2.0 Inflows 0.1 0.1 0.4 0.4 Outflows (0.2 ) - (0.4 ) (0.2 ) Net Flows (0.1 ) 0.1 - 0.2 Market Appreciation/(Depreciation) - (0.1 ) (0.4 ) 0.1 Foreign Exchange1 - - - - End of Period$ 2.0 $ 2.3 $ 2.0 $ 2.3 Total Assets Beginning of Period$ 31.5 $ 37.3 $ 41.2 $ 33.4 Inflows 2.8 0.9 5.6 4.0 Outflows (1.7 ) (1.7 ) (4.8 ) (4.6 ) Net Flows 1.1 (0.8 ) 0.8 (0.6 ) Market Appreciation/(Depreciation) 0.3 (0.7 ) (8.9 ) 3.0 Foreign Exchange1 0.4 - 0.2 - End of Period$ 33.3 $ 35.8 $ 33.3 $ 35.8
1 Foreign exchange reflects the impact of translating non-
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Three Months Ended
AtSeptember 30, 2020 , we managed$13.3 billion in separately managed accounts,$18.0 billion in sub-advised accounts, and$2.0 billion in Pzena funds, for a total of$33.3 billion in assets under management. For the three months endedSeptember 30, 2020 , we experienced market appreciation of$0.3 billion , an increase associated with foreign exchange movements of$0.4 billion , and total gross inflows of$2.8 billion , partially offset by total gross outflows of$1.7 billion . Assets in separately managed accounts increased by$0.3 billion , or 2.3%, from$13.0 billion atJune 30, 2020 , due to$0.1 billion in market appreciation, a$0.3 billion decrease associated with foreign exchange movements, and$0.2 billion in gross inflows, partially offset by$0.3 billion in gross outflows. Assets in sub-advised accounts increased by$1.6 billion , or 9.8%, from$16.4 billion atJune 30, 2020 , due to$0.2 billion in market appreciation, a$0.1 billion increase associated with foreign exchange movements, and$2.5 billion in gross inflows, partially offset by$1.2 billion in gross outflows. Assets in Pzena funds decreased by$0.1 billion , or 4.8%, from$2.1 billion atJune 30, 2020 , due to$0.2 billion in gross outflows, partially offset by$0.1 billion in gross inflows. AtSeptember 30, 2019 , we managed$13.7 billion in separately managed accounts,$19.8 billion in sub-advised accounts, and$2.3 billion in Pzena funds, for a total of$35.8 billion in assets under management. For the three months endedSeptember 30, 2019 , we experienced total gross out flows of$1.7 billion and total market depreciation of$0.7 billion , partially offset by total gross inflows of$0.9 billion . Assets in separately managed accounts decreased by$0.2 billion , or 1.4%, from$13.9 billion atJune 30, 2019 , due to$0.3 billion in market depreciation and gross outflows of$0.3 billion , partially offset by$0.4 billion in gross inflows. Assets in sub-advised accounts decreased by$1.3 billion , or 6.2%, from$21.1 billion atJune 30, 2019 , due to$1.4 billion in gross outflows and$0.3 billion in market depreciation, partially offset by$0.4 billion in gross inflows. Assets in Pzena funds remained flat at$2.3 billion fromJune 30, 2019 , due to$0.1 billion in gross inflows, offset by market depreciation of$0.1 billion .
Nine Months Ended
For the nine months endedSeptember 30, 2020 , we experienced market depreciation of$8.9 billion and total gross outflows of$4.8 billion , which were partially offset by total gross inflows of$5.6 billion and$0.2 billion increase associated with foreign exchange movements. Assets in separately managed accounts decreased by$3.1 billion , or 18.9%, from$16.4 billion atDecember 31, 2019 due to$3.4 billion in market depreciation and$1.0 billion in gross outflows, partially offset by$1.2 billion in gross inflows and$0.1 billion increase associated with foreign exchange movements. Assets in sub-advised accounts decreased by$4.4 billion , or 19.6%, from$22.4 billion atDecember 31, 2019 due to$5.1 billion in market depreciation and$3.4 billion in gross outflows, partially offset by$4.0 billion in gross inflows and$0.1 billion increase associated with foreign exchange movements. Assets in Pzena funds decreased by$0.4 billion , or 16.7%, from$2.4 billion atDecember 31, 2019 due to$0.4 billion in market depreciation and$0.4 billion in gross outflows, partially offset by$0.4 billion in gross inflows. For the nine months endedSeptember 30, 2019 , we experienced total gross outflows of$4.0 billion and market appreciation of$3.0 billion , which were partially offset by total gross outflows of$4.6 billion . Assets in separately managed accounts increased by$1.1 billion , or 8.7%, from$12.6 billion atDecember 31, 2018 due to$1.8 billion in gross inflows and$1.0 billion in market appreciation, partially offset by$1.7 billion in gross outflows. Assets in sub-advised accounts increased by$1.0 billion , or 5.3%, from$18.8 billion atDecember 31, 2018 due to$1.9 billion in market appreciation and$1.8 billion in gross inflows, partially offset by$2.7 billion in gross outflows. Assets in Pzena funds increased by$0.3 billion , or 15.0%, from$2.0 billion atDecember 31, 2018 due to$0.4 billion in gross inflows and$0.1 billion in market appreciation, partially offset by$0.2 billion in gross outflows. 35
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Table of Contents Revenue
Our revenue from advisory fees earned on our separately managed accounts,
sub-advised accounts, and Pzena funds for the three and nine months ended
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
Revenue 2020 2019 2020 2019
(in thousands)
Separately Managed Accounts $ 18,457 $ 18,548 $ 53,891 $ 55,959
Sub-Advised Accounts 11,880 14,651 34,851 44,715
Pzena Funds 3,611 3,866 10,016 11,644
Total $ 33,948 $ 37,065 $ 98,758 $ 112,318 Three Months Ended
Our total revenue decreased by$3.1 million , or 8.4%, to$33.9 million for the three months endedSeptember 30, 2020 , from$37.1 million for the three months endedSeptember 30, 2019 . This change was driven primarily by a decrease in our average AUM due to market depreciation during the first half of 2020. Average AUM decreased 8.1% to$33.1 billion from$36.0 billion for the three months endedSeptember 30, 2020 and 2019, respectively. We recognized no performance fees during the three months endedSeptember 30, 2020 , compared to$0.3 million recognized during the three months endedSeptember 30, 2019 .
Our weighted average fees were 0.410% and 0.412% for the three months ended
Average assets in separately managed accounts decreased 2.2% to$13.4 billion for the three months endedSeptember 30, 2020 , from$13.7 billion for the three months endedSeptember 30, 2019 , and had weighted average fees of 0.549% and 0.543% for the three months endedSeptember 30, 2020 and 2019, respectively. The increase in weighted average fee rate from the third quarter of 2019 primarily reflects the addition of assets to certain strategies that typically carry higher fee rates. Average assets in sub-advised accounts decreased 12.0% to$17.6 billion for the three months endedSeptember 30, 2020 , from$20.0 billion for the three months endedSeptember 30, 2019 , and had weighted average fees of 0.270% and 0.292% for the three months endedSeptember 30, 2020 and 2019, respectively. Certain accounts related to one retail client relationship have fulcrum fee arrangements. These fee arrangements require a reduction in the base fee or allow for a performance fee if the relevant investment strategy underperforms or outperforms, respectively, the agreed-upon benchmark over the contract's measurement period, which extends to three years. During the three months endedSeptember 30, 2020 and 2019, respectively, we recognized a$1.0 million and$0.5 million reduction in base fees, respectively, related to this client relationship. To the extent the three-year performance record of these accounts fluctuates relative to its relevant benchmark, the amount of base fees recognized may vary. Average assets in Pzena funds decreased 8.7% to$2.1 billion for the three months endedSeptember 30, 2020 , from$2.3 billion for the three months endedSeptember 30, 2019 , and had weighted average fees of 0.687% and 0.680% for the three months endedSeptember 30, 2020 and 2019, respectively. The increase from the third quarter of 2019 reflects a shift in asset mix toward products in strategies that typically carry higher fee rates.
Nine Months Ended
Our total revenue decreased by$13.5 million , or 12.0%, to$98.8 million for the nine months endedSeptember 30, 2020 , from$112.3 million for the nine months endedSeptember 30, 2019 . This decrease was driven primarily by decreases in our average AUM and performance-based fees.
Our weighted average fees were 0.393% and 0.413% for the nine months ended
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Average assets in separately managed accounts decreased$0.1 billion to$13.5 billion for the nine months endedSeptember 30, 2020 , from$13.6 billion for the nine months endedSeptember 30, 2019 , and had weighted average fees of 0.531% and 0.548% for the nine months endedSeptember 30, 2020 and 2019, respectively. The decrease in separately managed weighted average fee rates reflects a decrease in assets in non-U.S. strategies that generally carry higher fee rates. Average assets in sub-advised accounts decreased$2.4 billion to$17.9 billion for the nine months endedSeptember 30, 2020 , from$20.3 billion for the nine months endedSeptember 30, 2019 , and had weighted average fees of 0.259% and 0.293% for the nine months endedSeptember 30, 2020 and 2019, respectively. The decrease in sub-advised weighted average fee rates primarily reflects a decrease in performance fees recognized during the nine months endedSeptember 30, 2020 . In addition, certain accounts related to one retail client relationship have fulcrum fee arrangements. These fee arrangements require a reduction in the base fee or allow for a performance fee if the relevant investment strategy underperforms or outperforms, respectively, the agreed-upon benchmark over the contract's measurement period, which extends to three years. During the nine months endedSeptember 30, 2020 , we recognized a$3.0 million reduction in base fees related to this client relationship. We recognized a$1.0 million reduction in base fees during the nine months endedSeptember 30, 2019 . To the extent the three-year performance records of these accounts fluctuate relative to their relevant benchmarks, the amount of base fees recognized may vary. Average assets in Pzena funds decreased$0.2 billion to$2.1 billion for the nine months endedSeptember 30, 2020 , from$2.3 billion for the nine months endedSeptember 30, 2019 , and had weighted average fees of 0.646% and 0.687% for the nine months endedSeptember 30, 2020 and 2019, respectively. The decrease in weighted average fee rate for Pzena funds reflects an increase in fund expense cap reimbursements recognized during the nine months endedSeptember 30, 2020 , which are presented net against revenue.
Expenses
Our operating expenses are driven primarily by our compensation and benefits costs. The table below describes the components of our operating expenses for the three and nine months endedSeptember 30, 2020 and 2019. For the Three Months For the Nine Months Ended September 30, Ended September 30, 2020 2019 2020 2019 (in thousands)
Cash Compensation and Other Benefits
41,483 $ 40,744
Other Non-Cash Compensation 3,040 2,846 9,043 8,476
Total Compensation and Benefits Expense 15,808 16,012 50,526 49,220
General and Administrative Expense 3,183 3,905 11,180 12,186
Total Operating Expenses $ 18,991 $ 19,917 $ 61,706 $ 61,406 Three Months Ended
Total operating expenses decreased by$0.9 million , or 4.6%, to$19.0 million for the three months endedSeptember 30, 2020 , from$19.9 million for the three months endedSeptember 30, 2019 . This decrease reflects a decrease in general and administrative expenses, primarily driven by a decrease in travel and entertainment expense and professional fees. Compensation and benefits expense decreased by approximately$0.2 million , or 1.3%, to$15.8 million for the three months endedSeptember 30, 2020 , from$16.0 million for the three months endedSeptember 30, 2019 . The decrease from the third quarter of 2019 primarily reflects a decrease in the bonus accrual. General and administrative expense decreased by$0.7 million , or 18.5%, to$3.2 million for the three months endedSeptember 30, 2020 from$3.9 million for the three months endedSeptember 30, 2019 . The decrease in general and administrative expense reflects a decrease in travel costs and professional fees. 37
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Nine Months Ended
Total operating expenses increased by$0.3 million , or 0.5%, to$61.7 million for the nine months endedSeptember 30, 2020 , from$61.4 million for the nine months endedSeptember 30, 2019 . This increase was attributable to an increase in our compensation and benefits expenses offset by a decrease in general and administrative expense. Compensation and benefits expense increased by approximately$1.3 million , or 2.7%, to$50.5 million for the nine months endedSeptember 30, 2020 , from$49.2 million for the nine months endedSeptember 30, 2019 . This increase reflects an increase in the cost of employee departures, partially offset by a decrease in the bonus accrual. General and administrative expense decreased$1.0 million , or 8.3%, to$11.2 million for the nine months endedSeptember 30, 2020 , from$12.2 million for nine months endedSeptember 30, 2019 . The decrease in general and administrative expense reflects a decrease in travel costs and professional fees.
Other Income/ (Expense)
Three Months Ended
Other Income/ (Expense) was income of$0.5 million for the three months endedSeptember 30, 2020 , and consisted primarily of$0.1 million in equity in the earnings of affiliates,$0.2 million in net realized and unrealized gains from investments, and$0.1 million in interest income. Other Income/ (Expense) was income of less than$0.0 million for the three months endedSeptember 30, 2019 , and consisted primarily of$0.3 million in equity in the losses of affiliates,$0.1 million in dividend income, and$0.3 million in interest income.
Nine Months Ended
Other Income/ (Expense) was and expense of$5.6 million for the nine months endedSeptember 30, 2020 , and consisted primarily of$3.0 million in equity in the losses of affiliates and$3.2 million net realized and unrealized losses from investments, partially offset by$0.4 million in interest income, and$0.2 million in dividend income. Other Income/ (Expense) was income of$2.4 million for the nine months endedSeptember 30, 2019 , and consisted primarily of$1.0 million in equity in the earnings of affiliates,$0.5 million in expense related to net realized and unrealized gains from investments,$0.7 million in interest income and$0.4 million in dividend income.
Income Tax Expense
For the three and nine months ended
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
2020 2019 2020 2019
(in thousands)
Unincorporated and Other Business Tax
Expenses $ (1,044 ) $ (878 ) $ 151 $ 613
Total Corporate Tax Expense 961 1,124 2,129 3,540
Total Income Tax Expense $ (83 ) $ 246 $ 2,280 $ 4,153
The operating company is a limited liability company that has elected to be
treated as a partnership for tax purposes. The operating company has made a
provision for New York City Unincorporated Business Tax ("UBT") and its
consolidated subsidiary Pzena Investment Management, LTD has made a provision
for U.K. income taxes. The Company's provision for income taxes reflects its
U.S. federal, state, and local incomes taxes on its allocable portion of the
operating company's income. The effective tax rate includes a rate benefit
attributable to the fact that approximately 77.6% and 74.4% of the operating
company's earnings were not subject to corporate-level taxes for the nine months
ended September 30, 2020 and 2019, respectively. Income before income taxes
includes net income attributable to non-controlling interests and not taxable to
the Company, which reduces the effective tax rate. This favorable impact is
partially offset by the impact of certain permanently non-deductible
items. These factors are expected to continue to impact the effective tax rate
for future years and to the extent the Company's economic interest in the
operating company changes, the effective tax rate will likewise change with
variations in the level of income subject to corporate-level taxes. The
effective tax rate will also be affected by the discrete tax impact of
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future dividends on unvested share-based awards and future vesting of restricted share-based awards based on fluctuations in the trading price of the Company's Class A common stock between grant date and vesting date. Excluding discrete and permanently non-deductible items, which includes the net income attributable to non-controlling interest, the Company's effective tax rate was 24.3% and 25.0% for the three and nine months endedSeptember 30, 2020 , respectively, and 23.5% and 23.4% for each of the three and nine months endedSeptember 30, 2019 .
Three Months Ended
Income Tax Expense was$(0.1) million for the three months endedSeptember 30, 2020 and$0.2 million for the three months endedSeptember 30, 2019 . Income tax expense for the three months endedSeptember 30, 2020 consisted of$(1.0) million in operating company unincorporated and other business taxes and$1.0 million of corporate income taxes. Income tax expense for the three months endedSeptember 30, 2019 consisted of$(0.9) million in operating company unincorporated and other business taxes and$1.1 million of corporate income taxes.
Nine Months Ended
Income Tax Expense was$2.3 million for the nine months endedSeptember 30, 2020 and$4.2 million for the nine months endedSeptember 30, 2019 . Income tax expense for the nine months endedSeptember 30, 2020 consisted of$0.2 million in operating company unincorporated and other business taxes and of$2.1 million of corporate income taxes. Income tax expense for the nine months endedSeptember 30, 2019 consisted of$0.6 million in operating company unincorporated and other business taxes and$3.5 million of corporate income taxes. The decrease in income tax expense during for the nine months endedSeptember 30, 2020 reflects the decrease in income before income taxes during the nine months endedSeptember 30, 2020 .
Net Income Attributable to Non-Controlling Interests
Three Months Ended
Net income attributable to non-controlling interests was$12.9 million for the three months endedSeptember 30, 2020 , and consisted primarily of$12.8 million associated with our employees' and outside investors' approximately 78.0% weighted average interest in the income of the operating company and$0.1 million associated with the non-controlling interest in the income of our consolidated entities. Net income attributable to non-controlling interests was$13.4 million for the three months endedSeptember 30, 2019 , and consisted of$13.4 million associated with our employees' and outside investors' approximately 74.4% weighted average interest in the income of the operating company. The change in net income attributable to non-controlling interests primarily reflects the decrease in net income for the three months endedSeptember 30, 2020 , partially offset by an increase in our employees' and outside investors' weighted average interest in the income of the operating company. We expect the interests in our operating company in subsequent periods to depend on changes in our shareholder's equity and the size and composition of Class B and Class B-1 units awarded by our operating company's compensation plans.
Nine Months Ended
Net income attributable to non-controlling interests was$24.3 million for the nine months endedSeptember 30, 2020 , and consisted primarily of$24.3 million associated with our employees' and outside investors' approximately 77.6% weighted average interest in the income of the operating company. Net income attributable to non-controlling interests was$39.2 million for the nine months endedSeptember 30, 2019 , and consisted primarily of$39.0 million associated with our employees' and outside investors' approximately 74.4% weighted average interest in the income of the operating company and$0.2 million associated with the non-controlling interest in the income of our consolidated entities. The change in net income attributable to non-controlling interests primarily reflects the decrease in net income for the nine months endedSeptember 30, 2020 , partially offset by an increase in our employees' and outside investors' weighted average interest in the income of the operating company. We expect the interests in our operating company in subsequent periods to depend on changes in our shareholder's equity and the size and composition of Class B and Class B-1 units awarded by our operating company's compensation plans. 39
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Liquidity and Capital Resources
Historically, the working capital needs of our business have primarily been met through the cash generated by our operations. Distributions to members of our operating company are our largest use of cash. Other activities include purchases and sales of investments to fund our deferred compensation program, capital expenditures, and supporting strategic growth initiatives such as providing the initial cash investment in our mutual funds. We expect to fund the liquidity needs of our business in the next twelve months, and over the long term, primarily through cash generated from operations. As an investment management company, our business is materially affected by conditions in the global financial markets and economic conditions throughout the world. Our liquidity is highly dependent on the revenue and income from our operations, which is directly related to our levels of AUM. For the three months endedSeptember 30, 2020 , our average AUM and revenues decreased by 8.1% and 8.4%, respectively, compared to our average AUM and revenues for the three months endedSeptember 30, 2019 . AtSeptember 30, 2020 , cash and cash equivalents was$49.2 million , inclusive of$2.9 million in cash held by our consolidated subsidiaries. We also had$7.3 million in an open-ended mutual fund that can be sold to meet future cash flow needs and approximately$11.0 million in investments set aside to satisfy our obligations under our deferred compensation programs. Advisory fees receivable was$29.5 million . In determining the sufficiency of liquidity and capital resources to fund our business, we regularly monitor our liquidity position, including, among other things, cash, working capital, investments, long-term liabilities, lease commitments, and operating company distributions. Compensation is our largest expense. To the extent we deem necessary and appropriate to run our business, recognizing the need to retain our key personnel, we have the ability to change the absolute levels of our compensation packages, as well as change the mix of their cash and non-cash components. Historically, we have not tied our level of compensation directly to revenue, as manyWall Street firms do. Correspondingly, there is not a linear relationship between our compensation and the revenues we generate. This generally has the effect of increasing operating margins in periods of increased revenues, but can reduce operating margins when revenue declines. We regularly evaluate our staffing requirements and compensation levels with reference to our own liquidity position and external peer benchmarking data. The result of this review directly influences management's recommendations to our Board of Directors with respect to such staffing and compensation levels. We anticipate that tax allocations and dividend equivalent payments to the members of our operating company, which consist of certain of our employees, unaffiliated persons, former employees, and us, will continue to be a material financing activity. Cash distributions to operating company members for partnership tax allocations would increase should the taxable income of the operating company increase. Dividend equivalent payments will depend on our dividend policy and the discretion of our Board of Directors, as discussed below.
We believe that our lack of long-term debt, and ability to vary cash compensation levels, have provided us with an appropriate degree of flexibility in providing for our liquidity needs.
Dividend Policy
We are a holding company and our primary investment is our ownership of membership interests in our operating company. As a result, we depend upon distributions from our operating company to pay any dividends that our Board of Directors may declare to be paid to our Class A common stockholders. When, and if, our Board of Directors declares any such dividends, we then cause our operating company to make distributions to us in an amount sufficient to cover the dividends declared. Our dividend policy has certain risks and limitations, particularly with respect to liquidity. We may not pay dividends to our Class A common stockholders in amounts that have been paid to them in the past, or at all, if, among other things, we do not have the cash necessary to pay our intended dividends. To the extent we do not have cash on hand sufficient to pay dividends in the future, we may decide not to pay dividends. By paying cash dividends rather than investing that cash in our future growth, we risk slowing the pace of our growth, or not having a sufficient amount of cash to fund our operations or unanticipated capital expenditures, should the need arise. On an annual basis, our Board of Directors targets a cash dividend payout ratio of approximately 60% to 70% of our non-GAAP diluted net income, subject to growth initiatives and other funding needs. Our ability to pay dividends is subject to the Board of Directors' discretion and may be limited by our holding company structure and applicable provisions ofDelaware law. 40
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Table of Contents Tax Receivable Agreement Our purchase of membership units of our operating company concurrent with our initial public offering, and the subsequent and future exchanges by holders of Class B units of our operating company for shares of our Class A common stock (pursuant to the exchange rights provided for in the operating company's operating agreement), has resulted in, and is expected to continue to result in, increases in our share of the tax basis of the tangible and intangible assets of our operating company, which will increase the tax depreciation and amortization deductions that otherwise would not have been available to us. These increases in tax basis and tax depreciation and amortization deductions have reduced, and are expected to continue to reduce, the amount of cash taxes that we would otherwise be required to pay in the future. We entered into a tax receivable agreement with the current members of our operating company, the one member of our operating company immediately prior to our initial public offering who sold all membership units to us in connection with our initial public offering and any future holders of Class B units. This tax receivable agreement requires us to pay these members 85% of the amount of cash savings, if any, inU.S. federal, state and local income tax that we actually realize (or are deemed to realize in the case of an early termination payment by us, or a change in control, as described in the tax receivable agreement) as a result of the increases in tax basis described above and certain other tax benefits related to entering into the tax receivable agreement, including tax benefits attributable to payments under the tax receivable agreement.
Cash Flows
Three Months Ended
Cash, cash equivalents and restricted cash increased $16.1 million to $50.3
million during the three months ended September 30, 2020 compared to a $1.9
million increase in cash, cash equivalents and restricted cash to $36.7 million
during the three months ended September 30, 2019 . Net cash provided by operating
activities was $24.4 million for the three months ended September 30, 2020 ,
compared to $29.5 million for the three months ended September 30, 2019 . The
decrease in cash provided was primarily due to a decrease in net income and
changes in operating assets and liabilities and working capital.
Net cash provided by investing activities increased $16.8 million to $3.2
million for the three months ended September 30, 2020 from $13.6 million used
for the three months ended September 30, 2019 . The decrease in cash used in
investing activities was primarily due to a $16.0 million decrease in net
purchases of investments during the three months ended September 30, 2020 .
Net cash used in financing activities decreased by $2.5 million for the
three months ended September 30, 2020 to $11.5 million from $14.0 million for
the three months ended September 30, 2019 . The decrease in cash used is
primarily due to a $1.5 million decrease in distributions to non-controlling
interests and a $1.0 million decrease in the repurchase and retirement of shares
of Class A common stock.
Nine Months Ended
Cash and restricted cash decreased $3.1 million to $50.3 million during the
nine months ended September 30, 2020 compared to a $2.4 million decrease in cash
and restricted cash to $36.7 million during the nine months ended September 30,
2019 . Net cash provided by operating activities decreased $27.0 million in the
nine months ended September 30, 2020 to $31.4 million from $58.4 million in the
nine months ended September 30, 2019 . The decrease in cash provided was
primarily due to a decrease in net income and changes in operating assets and
liabilities and working capital.
Net cash provided by investing activities was $25.6 million for the nine
months ended September 30, 2020 , compared to net cash provided in investing
activities of $0.6 million for the nine months ended September 30, 2019 . The
increase in cash provided was primarily due to a $27.0 million increase in net
cash provided by sale of investments and a $1.0 million decrease in purchases of
property and equipment, partially offset by a $3.1 million increase in net cash
used associated with payments to/from related parties during the nine months
ended September 30, 2020 .
Net cash used in financing activities decreased $1.3 million for the nine
months ended September 30, 2020 to $60.1 million from $61.4 million for the nine
months ended September 30, 2019 . The decrease in cash used is primarily due to a
$1.1 million decrease in the repurchase and retirement of shares of Class A
common stock and Class B units, a $0.5 million decrease in net distributions to
non-controlling interests, and a $0.8 million decrease in dividend payments,
partially offset by a $2.2 million increase in the sale of shares under the
equity incentive program during the nine months ended September 30, 2020 .
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Table of Contents Contractual Obligations We are a smaller reporting company as defined by Rule 12b-2 of the Securities Exchange Act of 1934 and are not required to provide the information under this item.
Off-Balance Sheet Arrangements
We did not have any off-balance sheet arrangements as of
Critical Accounting Policies and Estimates
The preparation of our consolidated financial statements, in accordance with accounting principles generally accepted inthe United States of America ("U.S. GAAP"), requires management to make estimates and judgments that affect our reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under current circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily available from other sources. We evaluate our estimates on an ongoing basis. Actual results may materially differ from these estimates under different assumptions or conditions. Accounting policies are an integral part of our financial statements. A thorough understanding of these accounting policies is essential when reviewing our reported results of operations and our financial condition. Management believes that the critical accounting policies discussed below involve additional management judgment due to the sensitivity of the methods and assumptions used.
Consolidation
Our policy is to consolidate all majority-owned subsidiaries in which we have a controlling financial interest and variable-interest entities of which we are deemed to be the primary beneficiary. We assess our consolidation practices regularly, as circumstances dictate. All significant inter-company transactions and balances have been eliminated.
Income Taxes
We are a "C" corporation under the Internal Revenue Code, and thus liable for
federal, state and local taxes on the income derived from our economic interest
in our operating company. The operating company is a limited liability company
that has elected to be treated as a partnership for tax purposes. Our operating
company has not made a provision for federal or state income taxes because it is
the responsibility of each of the operating company's members (including us) to
separately report their proportionate share of the operating company's taxable
income or loss. Similarly, the income of our consolidated subsidiaries is not
subject to income taxes, as such income is allocated to each partnership's
individual partners. The operating company has made a provision for New York
City Unincorporated Business Tax.
We recognize deferred tax assets and liabilities for the future tax consequences
attributable to differences between the carrying amounts of existing assets and
liabilities and their respective tax bases, net operating loss carryforwards and
tax credits. A valuation allowance is recorded on our deferred tax assets when
it is more-likely-than-not that all or a portion of such assets will not be
realized. When evaluating the realizability of our deferred tax assets, all
evidence, both positive and negative, is evaluated, which requires management to
make significant judgments and assumptions. Items considered when evaluating the
need for a valuation allowance include our forecast of future taxable income,
future reversals of existing temporary differences, tax planning strategies and
other relevant considerations.
We believe that the accounting estimate related to the valuation allowance is a
critical accounting estimate because the underlying assumptions can change from
period to period. For example, tax law changes, or variances in future projected
operating performance, could result in a change in the valuation allowance. If
we are not able to realize all or part of our net deferred tax assets in the
future, an adjustment to our deferred tax asset valuation allowance would be
charged to income tax expense in the period such determination was made.
Management's judgment is required in determining our provision for income taxes,
evaluating our tax positions and establishing deferred tax assets and
liabilities. The calculation of our tax liabilities involves dealing with
uncertainties in the application of complex tax regulations. If the ultimate
resolution of uncertainties is different from currently estimated, it could
affect income tax expense and the effective tax rate.
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Recently Issued Accounting Pronouncements Not Yet Adopted
See Note 2, "Significant Accounting Policies - Recently Issued Accounting Pronouncements Not Yet Adopted" of the consolidated financial statements included in this Quarterly Report on Form 10-Q.
OnMarch 27, 2020 , theU.S. enacted the Coronavirus Aid, Relief and Economic Security ("CARES") Act. The CARES Act provides economic relief to eligible individuals and businesses impacted by the COVID-19 pandemic, including changes to tax policy. We are currently assessing what impact, if any, the CARES Act's provisions will have on our financial position, but we do not believe the impact will be material.
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