Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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 both U.S. and non-U.S. capital markets. At September 30, 2022, our assets under management, or AUM, was $42.0 billion. We manage separate accounts on behalf of institutions, act as sub-investment adviser for a variety of SEC-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. The percentages presented below are subject to continued changes, including but not limited to, the price of Class A common stock, issuance of awards, and exercise of options. Based on the closing price of the Company’s Class A common stock as of September 30, 2022, the holders of Class A common stock (through the Company), the holders of Class B units of the operating company, and Class B-1 units of the operating company held approximately 22.3%, 75.9%, and 1.8% respectively, of the economic interest in the September 30, 2022 value of the operating company. As of September 30, 2022, 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 20.1%, 68.4%, and 11.5%, respectively, of the future income and distributions.
The Company also serves as the general partner of Pzena 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 in Pzena Investment Management, LP and certain estate planning vehicles through which they indirectly own Class B and B-1 units of our operating company. Based on the closing price of the Company’s Class A common stock as of September 30, 2022, through direct and indirect interests, our three founders, 56 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 48.7%, 9.9%, and 19.1% of the economic interests in our operating company, respectively. As of September 30, 2022, through direct and indirect interests, our three founders, 56 other employee members, and certain former employees, collectively held 43.9%, 19.1%, and 16.9% of the future income and distributions of our operating company.
As announced on July 26, 2022, Pzena Investment Management, Inc. entered into a transaction whereby all of the outstanding public shares (known as Class A shares) of the Company would be converted into the right to receive $9.60 per share at the closing of the transaction. We believe that being a public company creates meaningful unnecessary expenses on our business, both in hard costs and in extra time for key members of our team. Further, as a well-established company at this stage, we believe we can effectively handle the issuance of equity to new employee partners within a private structure. And, our shares have very little liquidity, making it difficult for partners to transact in the market with almost any volume of shares. As an investment manager that relies on talented investment professionals, it is important for us to compensate our next generation with equity which creates dilution and can conflict with the market’s focus on short-term metrics.
On October 31, 2022, the Company completed its take-private transaction. The merger between Pzena Investment Management, Inc. and Panda Merger Sub, LLC, a wholly owned subsidiary of Pzena Investment Management, LLC became effective on October 31, 2022. As a result of the completed transaction, each share of the Company's Class A Common Stock was exchanged for $9.60 in cash, without interest and less any applicable withholding taxes. Effective October 31, 2022, the operating company will operate as a privately-held company owned by the existing partners of Pzena Investment Management, LLC. The Company's Class A Common Stock was suspended from trading prior to market open on October 31, 2022. The Company's Class A Common Stock will be removed from listing and registration on the New York Stock Exchange at the opening of business on November 14, 2022, pursuant to the provisions of Rule 12d2-2 (a).
Net Income
Diluted net income and diluted earnings per share were $12.8 million and $0.15, respectively, for the three months ended September 30, 2022, and $22.7 million and $0.27, respectively, for the three months ended September 30, 2021. Diluted net income and diluted earnings per share were $39.0 million and $0.45, respectively, for the nine months ended September 30, 2022, and $63.6 million and $0.76, respectively, for the nine months ended September 30, 2021.
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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 ended September 30, 2022 and 2021.
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 resulting effective tax rate was 27.4% and 27.6% for the three and nine months ended September 30, 2022, and 24.8% and 25.0% for the three and nine months ended September 30, 2021. 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 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, 2021.
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;
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•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, 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 on October 30, 2007. As discussed further below under “Tax Receivable Agreement,” this liability represents 85% of the amount of cash savings, if any, in U.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 of September 30, 2022, the holders of Class A common stock of the Company and the holders of Class B units and Class B-1 units of the operating company held approximately 22.3%, 75.9%, and 1.8% 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.
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The global effects of COVID-19 on the securities market caused a significant reduction in our AUM. While many businesses have re-opened, vaccinations are underway (particularly in the U.S., the U.K. and Israel) and leading economic indicators are showing signs of improvement, the overall extent and duration of COVID-19's impact on businesses and economic activity generally remains uncertain. The economic impact of COVID-19 and any additional declines in the financial markets could have a significant adverse effect on our AUM and revenues, particularly if economic activity does not continue to recover. Although countries throughout the world continue to grapple with re-opening their economies, this will continue to be a gradual process, and there is a significant risk that the opening process may be further interrupted if infection rates increase, as a result of the emergence of new variants of COVID-19 or otherwise.
Assets Under Management and Flows
As of September 30, 2022 and 2021, our AUM of approximately $42.0 billion and $50.8 billion, respectively, was invested in a variety of value-oriented investment strategies, representing distinct market capitalization segments of U.S. and non-U.S. equity markets. The assets under management and performance of our largest investment strategies as of September 30, 2022 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 of September 30, 2022 and 2021:
|
|
|
|
|
|
|
|
|
|
|
AUM at September 30, |
|
Strategy |
|
2022 |
|
|
2021 |
|
|
|
(in billions) |
|
U.S. Value Strategies |
|
|
|
|
|
|
Large Cap Value |
|
$ |
8.7 |
|
|
$ |
11.2 |
|
Mid Cap Value |
|
|
2.2 |
|
|
|
2.9 |
|
Small Cap Value |
|
|
2.0 |
|
|
|
2.5 |
|
Value |
|
|
0.4 |
|
|
|
0.7 |
|
Other U.S. Strategies |
|
|
0.2 |
|
|
|
0.2 |
|
Total U.S. Value Strategies |
|
|
13.5 |
|
|
|
17.5 |
|
|
|
|
|
|
|
|
Global and Non-U.S. Value Strategies |
|
|
|
|
|
|
Global Value |
|
|
13.6 |
|
|
|
14.8 |
|
International Value |
|
|
6.7 |
|
|
|
7.8 |
|
Emerging Markets Value |
|
|
5.4 |
|
|
|
7.2 |
|
European Value |
|
|
2.0 |
|
|
|
3.0 |
|
Other Global and Non-U.S. Strategies |
|
|
0.8 |
|
|
|
0.5 |
|
Total Global and Non-U.S. Value Strategies |
|
|
28.5 |
|
|
|
33.3 |
|
Total |
|
$ |
42.0 |
|
|
$ |
50.8 |
|
|
|
|
|
|
|
|
|
|
|
|
AUM at September 30, |
|
Account Domicile |
|
2022 |
|
|
2021 |
|
|
|
(in billions) |
|
U.S. |
|
$ |
26.4 |
|
|
$ |
31.2 |
|
Non-U.S. |
|
|
15.6 |
|
|
|
19.6 |
|
Total |
|
$ |
42.0 |
|
|
$ |
50.8 |
|
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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 to September 30, 2022, and in the five-year, three-year, and one-year periods ended September 30, 2022, 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, 20221 |
|
Investment Strategy (Inception Date) |
|
Since
Inception |
|
|
5 Years |
|
|
3 Years |
|
|
1 Year |
|
Large Cap Value (July 2012) |
|
|
|
|
|
|
|
|
|
|
|
|
Annualized Gross Returns |
|
|
10.2 |
% |
|
|
4.5 |
% |
|
|
5.5 |
% |
|
|
-11.1 |
% |
Annualized Net Returns |
|
|
9.8 |
% |
|
|
4.1 |
% |
|
|
5.1 |
% |
|
|
-11.4 |
% |
Russell 1000® Value Index |
|
|
9.6 |
% |
|
|
5.3 |
% |
|
|
4.4 |
% |
|
|
-11.4 |
% |
International Value (November 2008) |
|
|
|
|
|
|
|
|
|
|
|
|
Annualized Gross Returns |
|
|
7.1 |
% |
|
|
-0.6 |
% |
|
|
0.6 |
% |
|
|
-24.0 |
% |
Annualized Net Returns |
|
|
6.5 |
% |
|
|
-1.2 |
% |
|
|
0.0 |
% |
|
|
-24.4 |
% |
MSCI EAFE® Index—Net/U.S.$2 |
|
|
5.0 |
% |
|
|
-0.8 |
% |
|
|
-1.8 |
% |
|
|
-25.1 |
% |
Global Value (January 2010) |
|
|
|
|
|
|
|
|
|
|
|
|
Annualized Gross Returns |
|
|
6.7 |
% |
|
|
2.2 |
% |
|
|
3.6 |
% |
|
|
-18.3 |
% |
Annualized Net Returns |
|
|
6.1 |
% |
|
|
1.6 |
% |
|
|
3.0 |
% |
|
|
-18.8 |
% |
MSCI® World Index – Net/U.S.$2 |
|
|
7.8 |
% |
|
|
5.3 |
% |
|
|
4.6 |
% |
|
|
-19.6 |
% |
Emerging Markets Focused Value (January 2008) |
|
|
|
|
|
|
|
|
|
|
|
|
Annualized Gross Returns |
|
|
2.8 |
% |
|
|
1.2 |
% |
|
|
3.2 |
% |
|
|
-18.4 |
% |
Annualized Net Returns |
|
|
1.7 |
% |
|
|
0.2 |
% |
|
|
2.2 |
% |
|
|
-19.2 |
% |
MSCI® Emerging Markets Index—Net/U.S.$2 |
|
|
0.0 |
% |
|
|
-1.8 |
% |
|
|
-2.1 |
% |
|
|
-28.1 |
% |
Large Cap Focused Value (October 2000) |
|
|
|
|
|
|
|
|
|
|
|
|
Annualized Gross Returns |
|
|
6.8 |
% |
|
|
3.8 |
% |
|
|
5.4 |
% |
|
|
-12.6 |
% |
Annualized Net Returns |
|
|
6.1 |
% |
|
|
3.1 |
% |
|
|
4.7 |
% |
|
|
-13.2 |
% |
Russell 1000® Value Index |
|
|
6.5 |
% |
|
|
5.3 |
% |
|
|
4.4 |
% |
|
|
-11.4 |
% |
European Focused Value (August 2008) |
|
|
|
|
|
|
|
|
|
|
|
|
Annualized Gross Returns |
|
|
3.1 |
% |
|
|
-2.7 |
% |
|
|
-0.2 |
% |
|
|
-24.7 |
% |
Annualized Net Returns |
|
|
2.5 |
% |
|
|
-3.4 |
% |
|
|
-0.8 |
% |
|
|
-25.2 |
% |
MSCI® Europe Index – Net/U.S.$2 |
|
|
1.5 |
% |
|
|
-1.2 |
% |
|
|
-1.7 |
% |
|
|
-24.8 |
% |
Global Focused Value (January 2004) |
|
|
|
|
|
|
|
|
|
|
|
|
Annualized Gross Returns |
|
|
4.9 |
% |
|
|
1.7 |
% |
|
|
3.3 |
% |
|
|
-19.1 |
% |
Annualized Net Returns |
|
|
4.0 |
% |
|
|
0.9 |
% |
|
|
2.6 |
% |
|
|
-19.7 |
% |
MSCI® All Country World Index – Net/U.S.$2 |
|
|
6.4 |
% |
|
|
4.4 |
% |
|
|
3.7 |
% |
|
|
-20.7 |
% |
Mid Cap Value (April 2014) |
|
|
|
|
|
|
|
|
|
|
|
|
Annualized Gross Returns |
|
|
6.2 |
% |
|
|
3.5 |
% |
|
|
6.9 |
% |
|
|
-12.3 |
% |
Annualized Net Returns |
|
|
5.7 |
% |
|
|
3.1 |
% |
|
|
6.4 |
% |
|
|
-12.7 |
% |
Russell Mid Cap® Value Index |
|
|
6.4 |
% |
|
|
4.8 |
% |
|
|
4.5 |
% |
|
|
-13.6 |
% |
Small Cap Focused Value (January 1996) |
|
|
|
|
|
|
|
|
|
|
|
|
Annualized Gross Returns |
|
|
12.0 |
% |
|
|
3.0 |
% |
|
|
6.0 |
% |
|
|
-17.5 |
% |
Annualized Net Returns |
|
|
10.8 |
% |
|
|
1.9 |
% |
|
|
5.0 |
% |
|
|
-18.4 |
% |
Russell 2000® Value Index |
|
|
8.7 |
% |
|
|
2.9 |
% |
|
|
4.7 |
% |
|
|
-17.7 |
% |
Focused Value (January 1996) |
|
|
|
|
|
|
|
|
|
|
|
|
Annualized Gross Returns |
|
|
9.5 |
% |
|
|
2.6 |
% |
|
|
4.6 |
% |
|
|
-13.8 |
% |
Annualized Net Returns |
|
|
8.4 |
% |
|
|
1.6 |
% |
|
|
3.5 |
% |
|
|
-14.7 |
% |
Russell 1000® Value Index |
|
|
8.3 |
% |
|
|
5.3 |
% |
|
|
4.4 |
% |
|
|
-11.4 |
% |
International Focused Value (January 2004) |
|
|
|
|
|
|
|
|
|
|
|
|
Annualized Gross Returns |
|
|
4.9 |
% |
|
|
-0.7 |
% |
|
|
0.5 |
% |
|
|
-25.2 |
% |
Annualized Net Returns |
|
|
4.0 |
% |
|
|
-1.4 |
% |
|
|
-0.2 |
% |
|
|
-25.8 |
% |
MSCI® All Country World ex-U.S. Index – Net/U.S.$2 |
|
|
4.5 |
% |
|
|
-0.8 |
% |
|
|
-1.5 |
% |
|
|
-25.2 |
% |
Mid Cap Focused Value (September 1998) |
|
|
|
|
|
|
|
|
|
|
|
|
Annualized Gross Returns |
|
|
11.5 |
% |
|
|
5.1 |
% |
|
|
9.3 |
% |
|
|
-12.0 |
% |
Annualized Net Returns |
|
|
10.4 |
% |
|
|
4.1 |
% |
|
|
8.2 |
% |
|
|
-12.9 |
% |
Russell Mid Cap® Value Index |
|
|
9.4 |
% |
|
|
4.8 |
% |
|
|
4.5 |
% |
|
|
-13.6 |
% |
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.
2.Net of applicable withholding taxes and presented in U.S. Dollars
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Large Cap Value. This strategy reflects a portfolio composed of approximately 50 to 80 stocks drawn from a universe of 500 of the largest U.S. listed companies, based on market capitalization. This strategy was launched in July 2012. At September 30, 2022, the Large Cap Value strategy generated a one-year annualized gross return of (11.1)%, outperforming its benchmark. The top contributing sectors included the technology, energy, and telecommunications sectors, partially offset by underperformance of the consumer discretionary and industrials sector.
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 excluding the United States, based on market capitalization. This strategy was launched in November 2008. At September 30, 2022, the International Value strategy generated a one-year annualized gross return of (24.0)%, outperforming its benchmark. The top contributing sectors included the financials, information technology, and industrials sectors, partially offset by underperformance of the materials, consumer staples, utilities, and health care sectors.
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 in January 2010. At September 30, 2022, the Global Value strategy generated a one-year annualized gross return of (18.3)%, outperforming its benchmark. The top contributing sectors included the information technology, communication services, and energy sectors, partially offset by underperformance of the consumer discretionary, materials, and consumer staples 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 in January 2008. At September 30, 2022, the Emerging Markets Focused Value strategy generated a one-year annualized gross return of (18.4)%, outperforming its benchmark. The top contributing sectors included the information technology, consumer discretionary, communications services, financial services, utilities, and real estate sectors, partially offset by underperformance of the energy 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 largest U.S. listed companies, based on market capitalization. This strategy was launched in October 2000. At September 30, 2022, the Large Cap Focused Value strategy generated a one-year annualized gross return of (12.6)%, underperforming its benchmark. The top detracting sectors included the industrials, health care, and consumer discretionary sectors, partially offset by outperformance of the technology, energy, and telecommunications 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 in August 2008. At September 30, 2022, the European Focused Value strategy generated a one-year annualized gross return of (24.7)%, outperforming its benchmark. The top contributing sectors included industrials, information technology, and financial services sectors, partially offset by underperformance of the health care, consumer staples, and materials 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 in January 2004. At September 30, 2022, the Global Focused Value strategy generated a one-year annualized gross return of (19.1)%, outperforming its benchmark. The top contributing sectors included the energy, information technology, and communication services sectors, partially offset by underperformance of the consumer discretionary and materials sectors.
Mid Cap Value. This strategy reflects a portfolio composed of approximately 50 to 80 stocks drawn from a universe of U.S. listed companies ranked from the 201st to 1,200th largest, based on market capitalization. This strategy was launched in April 2014. At September 30, 2022, the Mid Cap Value strategy generated a one-year annualized gross return of (12.3)%, outperforming its benchmark. The top contributing sectors included the energy, financial services, and technology sectors, partially offset by underperformance of the industrials and consumer staples sectors.
Small Cap Focused Value. This strategy reflects a portfolio composed of approximately 40 to 50 stocks drawn from a universe of U.S. listed companies ranked from the 1,001st to 3,000th largest, based on market capitalization. This strategy was launched in January 1996. At September 30, 2022, the Small Cap Focused Value strategy generated a one-year annualized gross return of (17.5)%, outperforming its benchmark. The top contributing sectors included the health care, financial services, and technology sectors, partially offset by the underperformance of the industrials, consumer discretionary, and consumer staples 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 largest U.S. listed companies, based on market capitalization. This strategy was launched in January 1996. At September 30, 2022, the Focused Value strategy generated a one-year annualized gross return of (13.8)%, underperforming its benchmark. The top detracting sectors included the consumer discretionary, industrials, and health care sectors, partially offset by the outperformance of the energy and technology sectors.
35
Table of Contents
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 excluding the United States, based on market capitalization. This strategy was launched in January 2004. At September 30, 2022, the International Focused Value strategy generated a one-year annualized gross return of (25.2)%, meeting its benchmark. The top contributing sectors included the information technology and communication services sectors, offset by the underperformance of the materials sector.
Mid Cap Focused Value. This strategy reflects a portfolio composed of approximately 30 to 40 stocks drawn from a universe of U.S. listed companies ranked from the 201st to 1,200th largest, based on market capitalization. This strategy was launched in September 1998. At September 30, 2022, the Mid Cap Focused Value strategy generated a one-year annualized gross return of (12.0)%, outperforming its benchmark. The top contributing sectors included the energy, technology, and financial services sectors, partially offset by the underperformance of the industrials and consumer discretionary 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.
36
Table of Contents
The change in AUM in our separately managed accounts, sub-advised accounts, and Pzena funds for the three and nine months ended September 30, 2022 and 2021 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
Ended September 30, |
|
|
For the Nine Months
Ended September 30, |
|
|
|
2022 |
|
|
2021 |
|
|
2022 |
|
|
2021 |
|
Separately Managed Accounts |
|
|
|
|
|
|
|
|
|
|
|
|
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
Beginning of Period |
|
$ |
16.4 |
|
|
$ |
20.0 |
|
|
$ |
19.4 |
|
|
$ |
17.3 |
|
Inflows |
|
|
0.3 |
|
|
|
0.2 |
|
|
|
0.7 |
|
|
|
1.6 |
|
Outflows |
|
|
(1.2 |
) |
|
|
(1.1 |
) |
|
|
(2.2 |
) |
|
|
(2.8 |
) |
Net Flows |
|
|
(0.9 |
) |
|
|
(0.9 |
) |
|
|
(1.5 |
) |
|
|
(1.2 |
) |
Market Appreciation/(Depreciation) |
|
|
(1.0 |
) |
|
|
(0.1 |
) |
|
|
(2.7 |
) |
|
|
3.1 |
|
Foreign Exchange1 |
|
|
(0.5 |
) |
|
|
(0.2 |
) |
|
|
(1.2 |
) |
|
|
(0.4 |
) |
End of Period |
|
$ |
14.0 |
|
|
$ |
18.8 |
|
|
$ |
14.0 |
|
|
$ |
18.8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sub-Advised Accounts |
|
|
|
|
|
|
|
|
|
|
|
|
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
Beginning of Period |
|
$ |
26.1 |
|
|
$ |
30.2 |
|
|
$ |
30.5 |
|
|
$ |
23.3 |
|
Inflows |
|
|
3.2 |
|
|
|
1.3 |
|
|
|
5.1 |
|
|
|
5.9 |
|
Outflows |
|
|
(1.1 |
) |
|
|
(1.7 |
) |
|
|
(3.8 |
) |
|
|
(3.9 |
) |
Net Flows |
|
|
2.1 |
|
|
|
(0.4 |
) |
|
|
1.3 |
|
|
|
2.0 |
|
Market Appreciation/(Depreciation) |
|
|
(2.0 |
) |
|
|
(0.3 |
) |
|
|
(4.8 |
) |
|
|
4.3 |
|
Foreign Exchange1 |
|
|
(0.6 |
) |
|
|
(0.2 |
) |
|
|
(1.4 |
) |
|
|
(0.3 |
) |
End of Period |
|
$ |
25.6 |
|
|
$ |
29.3 |
|
|
$ |
25.6 |
|
|
$ |
29.3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pzena Funds |
|
|
|
|
|
|
|
|
|
|
|
|
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
Beginning of Period |
|
$ |
2.5 |
|
|
$ |
2.9 |
|
|
$ |
2.6 |
|
|
$ |
2.7 |
|
Inflows |
|
|
0.3 |
|
|
|
0.1 |
|
|
|
0.8 |
|
|
|
0.5 |
|
Outflows |
|
|
(0.2 |
) |
|
|
(0.2 |
) |
|
|
(0.4 |
) |
|
|
(0.7 |
) |
Net Flows |
|
|
0.1 |
|
|
|
(0.1 |
) |
|
|
0.4 |
|
|
|
(0.2 |
) |
Market Appreciation/(Depreciation) |
|
|
(0.1 |
) |
|
|
— |
|
|
|
(0.3 |
) |
|
|
0.4 |
|
Foreign Exchange1 |
|
|
(0.1 |
) |
|
|
(0.1 |
) |
|
|
(0.3 |
) |
|
|
(0.2 |
) |
End of Period |
|
$ |
2.4 |
|
|
$ |
2.7 |
|
|
$ |
2.4 |
|
|
$ |
2.7 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
|
|
|
|
|
|
|
|
|
|
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
Beginning of Period |
|
$ |
45.0 |
|
|
$ |
53.1 |
|
|
$ |
52.5 |
|
|
$ |
43.3 |
|
Inflows |
|
|
3.8 |
|
|
|
1.6 |
|
|
|
6.6 |
|
|
|
8.0 |
|
Outflows |
|
|
(2.5 |
) |
|
|
(3.0 |
) |
|
|
(6.4 |
) |
|
|
(7.4 |
) |
Net Flows |
|
|
1.3 |
|
|
|
(1.4 |
) |
|
|
0.2 |
|
|
|
0.6 |
|
Market Appreciation/(Depreciation) |
|
|
(3.1 |
) |
|
|
(0.4 |
) |
|
|
(7.8 |
) |
|
|
7.8 |
|
Foreign Exchange1 |
|
|
(1.2 |
) |
|
|
(0.5 |
) |
|
|
(2.9 |
) |
|
|
(0.9 |
) |
End of Period |
|
$ |
42.0 |
|
|
$ |
50.8 |
|
|
$ |
42.0 |
|
|
$ |
50.8 |
|
1.Foreign exchange reflects the impact of translating non-U.S. dollar denominated AUM into U.S. dollars for reporting purposes.
37
Table of Contents
Three Months Ended September 30, 2022 and September 30, 2021
At September 30, 2022, we managed $14.0 billion in separately managed accounts, $25.6 billion in sub-advised accounts, and $2.4 billion in Pzena funds, for a total of $42.0 billion in assets under management. For the three months ended September 30, 2022, we experienced total gross outflows of $2.5 billion, market depreciation of $3.1 billion, and a decrease associated with foreign exchange movements of $1.2 billion, partially offset by total gross inflows of $3.8 billion. Assets in separately managed accounts decreased by $2.4 billion, or 14.6%, from $16.4 billion at June 30, 2022, due to $1.2 billion in gross outflows, $1.0 billion in market depreciation, and a $0.5 billion decrease associated with foreign exchange movements, offset by $0.3 billion in gross inflows. Assets in sub-advised accounts decreased by $0.5 billion, or 1.9%, from $26.1 billion at June 30, 2022, due to $1.1 billion in gross outflows, $2.0 billion in market depreciation, and a $0.6 billion decrease associated with foreign exchange movements, partially offset by $3.2 billion in gross inflows. Assets in Pzena funds decreased by $0.1 billion, or 4.0%, from $2.5 billion at June 30, 2022, due to $0.2 billion in gross outflows, $0.1 billion in market depreciation, and a $0.1 billion decrease associated with foreign exchange movements, partially offset by $0.3 billion in gross inflows.
At September 30, 2021, we managed $18.8 billion in separately managed accounts, $29.3 billion in sub-advised accounts, and $2.7 billion in Pzena funds, for a total of $50.8 billion in assets under management. For the three months ended September 30, 2021, we experienced total gross outflows of $3.0 billion, market depreciation of $0.4 billion, and a decrease associated with foreign exchange movements of $0.5 billion, partially offset by total gross inflows of $1.6 billion. Assets in separately managed accounts decreased by $1.2 billion, or 6.0%, from $20.0 billion at June 30, 2021, due to $1.1 billion in gross outflows, $0.1 billion in market depreciation, and a $0.2 billion decrease associated with foreign exchange movements, partially offset by $0.2 billion in gross inflows. Assets in sub-advised accounts decreased by $0.9 billion, or 3.0%, from $30.2 billion at June 30, 2021, due to $1.7 billion in gross outflows, $0.3 billion in market depreciation, and a $0.2 billion decrease associated with foreign exchange movements, partially offset by $1.3 billion in gross inflows. Assets in Pzena funds decreased by $0.2 billion, or 6.9%, from $2.9 billion at June 30, 2021, due to $0.2 billion in gross outflows and $0.1 billion decrease associated with foreign exchange movements , partially offset by $0.1 billion in gross inflows.
Nine Months Ended September 30, 2022 and September 30, 2021
For the nine months ended September 30, 2022, we experienced market depreciation of $7.8 billion, total gross outflows of $6.4 billion, and a $2.9 billion decrease associated with foreign exchange movements, which were partially offset by total gross inflows of $6.6 billion. Assets in separately managed accounts decreased by $5.4 billion, or 27.8%, from $19.4 billion at December 31, 2021, due to $2.7 billion in market depreciation, $2.2 billion in gross outflows, and a $1.2 billion decrease associated with foreign exchange movements, partially offset by $0.7 billion in gross inflows . Assets in sub-advised accounts decreased by $4.9 billion, or 16.1%, from $30.5 billion at December 31, 2021 due to $4.8 billion in market depreciation, $3.8 billion in gross outflows, and a $1.4 billion decrease associated with foreign exchange movements, partially offset by $5.1 billion in gross inflows. Assets in Pzena funds decreased by $0.2 billion, or 7.7%, from $2.6 billion at December 31, 2021 due to $0.3 billion in market depreciation, $0.4 billion in gross outflows, and a $0.3 billion decrease associated with foreign exchange movements, partially offset by $0.8 billion in gross inflows.
For the nine months ended September 30, 2021, we experienced market appreciation of $7.8 billion and total gross inflows of $8.0 billion, which were partially offset by total gross outflows of $7.4 billion and a $0.9 billion decrease associated with foreign exchange movements. Assets in separately managed accounts increased by $1.5 billion, or 8.7%, from $17.3 billion at December 31, 2020, due to $3.1 billion in market appreciation and $1.6 billion in gross inflows, partially offset by $2.8 billion in gross outflows and $0.4 billion decrease associated with foreign exchange movements. Assets in sub-advised accounts increased by $6.0 billion, or 25.8%, from $23.3 billion at December 31, 2020 due to $4.3 billion in market appreciation and $5.9 billion in gross inflows, partially offset by $3.9 billion in gross outflows and $0.3 billion decrease associated with foreign exchange movements. Assets in Pzena funds remained flat from $2.7 billion at December 31, 2020 due to $0.4 billion in market appreciation and $0.5 billion in gross inflows, partially offset by $0.7 billion in gross outflows and $0.2 billion decrease associated with foreign exchange movements.
38
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 September 30, 2022 and 2021 is described below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months
Ended September 30, |
|
|
For the Nine Months
Ended September 30, |
|
Revenue |
|
2022 |
|
|
2021 |
|
|
2022 |
|
|
2021 |
|
|
|
(in thousands) |
|
Separately Managed Accounts |
|
$ |
21,039 |
|
|
$ |
26,016 |
|
|
$ |
70,979 |
|
|
$ |
77,088 |
|
Sub-Advised Accounts |
|
|
19,981 |
|
|
|
20,786 |
|
|
|
62,477 |
|
|
|
56,814 |
|
Pzena Funds |
|
|
4,224 |
|
|
|
4,820 |
|
|
|
13,245 |
|
|
|
14,468 |
|
Total |
|
$ |
45,244 |
|
|
$ |
51,622 |
|
|
$ |
146,701 |
|
|
$ |
148,370 |
|
Three Months Ended September 30, 2022 and September 30, 2021
Our total revenue decreased by $6.4 million, or 12.4%, to $45.2 million for the three months ended September 30, 2022, from $51.6 million for the three months ended September 30, 2021. This change was driven primarily by a decrease in our average AUM due to market depreciation during the third quarter of 2022. Average AUM decreased 13.4% to $45.4 billion from $52.4 billion for the three months ended September 30, 2022 and 2021, respectively. We recognized performance fees of $0.6 million during the three months ended September 30, 2022, compared to performance fees of less than $0.1 million recognized during the three months ended September 30, 2021.
Our weighted average fees were 0.398% and 0.394% for the three months ended September 30, 2022 and 2021, respectively.
Average assets in separately managed accounts decreased 19.5% to $15.7 billion for the three months ended September 30, 2022, from $19.5 billion for the three months ended September 30, 2021, and had weighted average fees of 0.537% and 0.534% for the three months ended September 30, 2022 and 2021, respectively.
Average assets in sub-advised accounts decreased 9.6% to $27.2 billion for the three months ended September 30, 2022, compared to $30.1 billion for the three months ended September 30, 2021, and had weighted average fees of 0.293% and 0.276% for the three months ended September 30, 2022 and 2021, respectively. The increase in sub-advised weighted average fee rates reflects an increase in performance fees recognized during the third quarter of 2022. 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 an increase in the base 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 ended September 30, 2022, the Company recognized $0.6 million of performance fees related to this client relationship. During the three months ended September 30, 2021, the Company recognized a $1.0 million reduction in base fees 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 to $2.5 billion for the three months ended September 30, 2022, compared to $2.8 billion for the three months ended September 30, 2021, and had weighted average fees of 0.679% and 0.690% for the three months ended September 30, 2022 and 2021, respectively. The decrease from the third quarter of 2021 primarily reflects an increase in expense reimbursements.
Nine Months Ended September 30, 2022 and September 30, 2021
Our total revenue decreased by $1.7 million, or 1.1%, to $146.7 million for the nine months ended September 30, 2022, from $148.4 million for the nine months ended September 30, 2021. This decrease was driven primarily by increases in our average AUM.
Our weighted average fees were 0.396% and 0.399% for the nine months ended September 30, 2022 and 2021, respectively.
Average assets in separately managed accounts decreased $1.2 billion to $17.8 billion for the nine months ended September 30, 2022, from $19.0 billion for the nine months ended September 30, 2021, and had weighted average fees of 0.532%
39
Table of Contents
and 0.540% for the nine months ended September 30, 2022 and 2021, respectively. The decrease from the third quarter of 2021 primarily reflects a shift in assets to certain strategies that typically carry lower fee rates.
Average assets in sub-advised accounts increased $1.3 billion to $29.0 billion for the nine months ended September 30, 2022, from $27.7 billion for the nine months ended September 30, 2021, and had weighted average fees of 0.287% and 0.274% for the nine months ended September 30, 2022 and 2021, respectively. The increase in sub-advised weighted average fee rates reflects an increase in performance fees recognized during the nine months ended September 30, 2022. 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 ended September 30, 2022, we recognized $1.8 million of performance fees related to this client relationship. During the nine months ended September 30, 2021, we recognized a $3.0 million reduction in base fees related to this client relationship. 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 $2.6 billion for the nine months ended September 30, 2022, from $2.8 billion for the nine months ended September 30, 2021, and had weighted average fees of 0.682% and 0.686% for the nine months ended September 30, 2022 and 2021, respectively. The decrease in weighted average fee rate for Pzena funds reflects an increase in expense reimbursements and performance fees recognized during the nine months ended September 30, 2022.
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 ended September 30, 2022 and 2021.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months
Ended September 30, |
|
|
For the Nine Months
Ended September 30, |
|
|
|
2022 |
|
|
2021 |
|
|
2022 |
|
|
2021 |
|
|
|
(in thousands) |
|
Cash Compensation and Other Benefits |
|
$ |
15,260 |
|
|
$ |
14,946 |
|
|
$ |
47,109 |
|
|
$ |
45,365 |
|
Other Non-Cash Compensation |
|
|
3,370 |
|
|
|
3,975 |
|
|
|
11,133 |
|
|
|
11,726 |
|
Total Compensation and Benefits Expense |
|
|
18,630 |
|
|
|
18,921 |
|
|
|
58,242 |
|
|
|
57,091 |
|
General and Administrative Expense |
|
|
8,962 |
|
|
|
4,304 |
|
|
|
19,625 |
|
|
|
11,920 |
|
Total Operating Expenses |
|
$ |
27,592 |
|
|
$ |
23,225 |
|
|
$ |
77,867 |
|
|
$ |
69,011 |
|
Three Months Ended September 30, 2022 and September 30, 2021
Total operating expenses increased by $4.4 million, or 18.8%, to $27.6 million for the three months ended September 30, 2022, from $23.2 million for the three months ended September 30, 2021. This increase was attributable to an increase in general and administrative expense offset by a decrease in compensation and benefits expense.
Compensation and benefits expense decreased by $0.3 million, or 1.5%, to $18.6 million for the three months ended September 30, 2022, from $18.9 million for the three months ended September 30, 2021. The decrease in compensation and benefits expense reflects a decrease in compensation and the market performance of strategies tied to the Company’s deferred compensation obligation.
General and administrative expense increased by $4.7 million, or 108.2%, to $9.0 million for the three months ended September 30, 2022, from $4.3 million for the three months ended September 30, 2021. The increase in general and administrative expenses primarily reflects an increase in professional fees associated with the ongoing take private transaction and occupancy costs.
Nine Months Ended September 30, 2022 and September 30, 2021
Total operating expenses increased by $8.9 million, or 12.8%, to $77.9 million for the nine months ended September 30, 2022, from $69.0 million for the nine months ended September 30, 2021. This increase was attributable to increases in both our compensation and benefits expense and general and administrative expense.
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Compensation and benefits expense increased by approximately $1.2 million, or 2.0%, to $58.2 million nine months ended September 30, 2022, from $57.1 million for the nine months ended September 30, 2021. The increase is driven by an increase in headcount and compensation.
General and administrative expense increased by $7.7 million, or 64.6%, to $19.6 million for the nine months ended September 30, 2022, from $11.9 million for nine months ended September 30, 2021. The increase in general and administrative expense reflects an increase in professional fees associated with the ongoing take private transaction and occupancy costs.
Other Income/ (Expense)
Three Months Ended September 30, 2022 and September 30, 2021
Other Income/ (Expense) was expense of $4.5 million for the three months ended September 30, 2022, and consisted primarily of $3.3 million in net realized and unrealized losses from investments and $2.2 million in equity in the losses of affiliates, partially offset by $0.7 million in interest income and $0.3 million in dividend income. Other Income/ (Expense) was income of $0.4 million for the three months ended September 30, 2021, and consisted primarily of $0.1 million in net realized and unrealized gains from investments and $0.3 million in dividend income.
Nine Months Ended September 30, 2022 and September 30, 2021
Other Income/ (Expense) was expense of $12.1 million for the nine months ended September 30, 2022, and consisted primarily of $10.0 million net realized and unrealized losses from investments and $3.9 million in equity in the losses of affiliates, partially offset by $1.4 million in dividend income and $0.8 million in interest income. Other Income/ (Expense) was income of $6.5 million for the nine months ended September 30, 2021, and consisted primarily of $3.5 million net realized and unrealized gains from investments, $2.0 million in equity in the earnings of affiliates, $0.7 million in dividend income, and $0.2 million in interest income.
Income Tax Expense
For the three and nine months ended September 30, 2022 and 2021, components of our income tax expense are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months
Ended September 30, |
|
|
For the Nine Months
Ended September 30, |
|
|
|
2022 |
|
|
2021 |
|
|
2022 |
|
|
2021 |
|
|
|
(in thousands) |
|
Unincorporated and Other Business Tax Expenses |
|
$ |
(3,569 |
) |
|
$ |
(1,550 |
) |
|
$ |
4,894 |
|
|
$ |
371 |
|
Total Corporate Tax Expense |
|
|
919 |
|
|
|
1,618 |
|
|
|
3,171 |
|
|
|
4,638 |
|
Total Income Tax Expense/ (Benefit) |
|
$ |
(2,650 |
) |
|
$ |
68 |
|
|
$ |
8,065 |
|
|
$ |
5,009 |
|
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 79.6% and 78.2% of the operating company's earnings were not subject to corporate-level taxes for the nine months ended September 30, 2022 and 2021, 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 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 27.4% and 27.6% for the three and nine months ended September 30, 2022, respectively, and 24.8% and 25.0% for the three and nine months ended September 30, 2021, respectively.
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Three Months Ended September 30, 2022 and September 30, 2021
Income Tax Expense/ (Benefit) was a benefit of $2.7 million for the three months ended September 30, 2022 and expense of $0.1 million for the three months ended September 30, 2021. Income Tax Expense/ (Benefit) for the three months ended September 30, 2022 consisted of a $3.6 million benefit in operating company unincorporated and other business taxes and $0.9 million of corporate income taxes. Income tax expense for the three months ended September 30, 2021 consisted of a $1.6 million benefit in operating company unincorporated and other business taxes and $1.6 million of corporate income taxes.
Nine Months Ended September 30, 2022 and September 30, 2021
Income Tax Expense/ (Benefit) was expense of $8.1 million for the nine months ended September 30, 2022 and expense of $5.0 million for the nine months ended September 30, 2021. Income Tax Expense for the nine months ended September 30, 2022 consisted of $4.9 million in operating company unincorporated and other business taxes and of $3.2 million of corporate income taxes. Income tax expense for the nine months ended September 30, 2021 consisted of $0.4 million in operating company unincorporated and other business taxes and $4.6 million of corporate income taxes. The increase in income tax expense during the nine months ended September 30, 2022 reflects a $5.9 million expense associated with a change in estimate of uncertain tax positions due to a change in interpretation of administrative rulings recognized during the first quarter of 2022.
Net Income Attributable to Non-Controlling Interests
Three Months Ended September 30, 2022 and September 30, 2021
Net income attributable to non-controlling interests was $13.1 million for the three months ended September 30, 2022, and consisted primarily of $13.9 million associated with our employees’ and outside investors’ approximately 79.9% weighted average interest in the income of the operating company and $0.8 million associated with the non-controlling interest in the losses of our consolidated entities. Net income attributable to non-controlling interests was $23.6 million for the three months ended September 30, 2021, and consisted of $23.4 million associated with our employees’ and outside investors’ approximately 77.9% weighted average interest in the income of the operating company and $0.3 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 a decrease in net income for the three months ended September 30, 2022. 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 September 30, 2022 and September 30, 2021
Net income attributable to non-controlling interests was $40.7 million for the nine months ended September 30, 2022, and consisted primarily of $42.8 million associated with our employees’ and outside investors’ approximately 79.6% weighted average interest in the income of the operating company and $2.1 million associated with the non-controlling interest in the losses of our consolidated entities. Net income attributable to non-controlling interests was $67.0 million for the nine months ended September 30, 2021, and consisted primarily of $66.3 million associated with our employees’ and outside investors’ approximately 78.2% weighted average interest in the income of the operating company and $0.7 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 ended September 30, 2022, 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.
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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 ended September 30, 2022, our average AUM and revenues decreased by 13.4% and 12.4%, respectively, compared to our average AUM and revenues for the three months ended September 30, 2021. At September 30, 2022, cash and cash equivalents was $75.0 million, inclusive of $12.5 million in cash held by our consolidated subsidiaries. We also had approximately $17.2 million in investments set aside to satisfy our obligations under our deferred compensation programs and advisory fees receivable of $34.5 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 many Wall 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 of Delaware law.
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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, in U.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 September 30, 2022 and September 30, 2021
Cash, cash equivalents and restricted cash increased $25.5 million to $77.2 million during the three months ended September 30, 2022 compared to a $16.5 million increase in cash, cash equivalents and restricted cash to $71.0 million during the three months ended September 30, 2021. Net cash provided by operating activities was $42.7 million for the three months ended September 30, 2022, compared to net cash provided by operating activities of $29.1 million for the three months ended September 30, 2021. The increase in cash provided was primarily due to the changes in operating assets and liabilities and working capital.
Net cash used in investing activities increased $6.6 million to $6.7 million for the three months ended September 30, 2022 from $0.1 million provided in the three months ended September 30, 2021. The increase in cash used in investing activities was primarily due to a $3.5 million increase in deconsolidation of sponsored investment funds and $3.1 million increase in purchases of property and equipment during the three months ended September 30, 2022.
Net cash used in financing activities decreased $2.1 million to $10.4 million for the three months ended September 30, 2022 from $12.5 million for the three months ended September 30, 2021. The change in cash used is primarily due to a $2.4 million decrease in repurchase and retirements of Class A Common Stock, partially offset by a $0.3 million increase in net distributions from non-controlling interests during the three months ended September 30, 2022.
Nine Months Ended September 30, 2022 and September 30, 2021
Cash, cash equivalents and restricted cash decreased $5.0 million to $77.2 million during the nine months ended September 30, 2022 compared to a $4.4 million decrease in cash, cash equivalents and restricted cash to $71.0 million during the nine months ended September 30, 2021. Net cash provided by operating activities was $59.8 million for the nine months ended September 30, 2022, compared to net cash provided by operating activities of $54.6 million for the nine months ended September 30, 2021. The decrease in cash provided was primarily due to changes in operating assets and liabilities and working capital.
Net cash used in investing activities increased $6.6 million to $6.7 million for the nine months ended September 30, 2022 from $0.1 million provided for the nine months ended September 30, 2021. The increase in cash used in investing activities was primarily due to a $6.3 million increase in deconsolidation of sponsored investment funds, a $5.0 million increase in purchases of property and equipment, and a $0.4 million increase in payments to related parties, partially offset by a $5.0 million increase in net sales of investments during the nine months ended September 30, 2022.
Net cash used in financing activities increased by $7.9 million to $58.1 million for the nine months ended September 30, 2022 from $50.2 million for the nine months ended September 30, 2021. The increase in cash used is primarily due to a $5.3 million increase in net distributions to non-controlling interests and a $4.9 million increase in dividends paid, partially offset by a $1.5 million decrease in the sale of shares under equity incentive plans and a $0.7 million decrease in repurchase and retirements of Class A Common Stock and Class B Units during the nine months ended September 30, 2022.
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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 September 30, 2022.
Critical Accounting Policies and Estimates
The preparation of our consolidated financial statements, in accordance with accounting principles generally accepted in the 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
None.