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professional_accounting | 747,088 | 507.093297 | 15 | x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 29, 2008
¨ TRANSITION REPORT PURSUANT TO SECTION 13 or 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
CARROLS RESTAURANT GROUP, INC.
(Address of principal executive office) (Zip Code)
CARROLS CORPORATION
Registrant’s telephone number including area code: (315) 424-0513
Carrols Corporation meets the conditions set forth in General Instruction H(1) and is therefore filing this form with reduced disclosure format pursuant to General Instruction H(2).
Indicate by check mark whether either of the registrants (1) have filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant were required to file such reports), and (2) have been subject to such filing requirements for the past 90 days.
Yes x No ¨
Indicate by check mark whether the registrants are large accelerated filers, accelerated filers, non-accelerated filers or smaller reporting companies. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act, (Check one):
Large accelerated filer ¨ Accelerated filer x
Non-accelerated filer (Do not check if a smaller reporting company) ¨ Smaller reporting company ¨
Large accelerated filer ¨ Accelerated filer ¨
Non-accelerated filer (Do not check if a smaller reporting company) x Smaller reporting company ¨
Indicate by check mark whether either of the registrants are shell companies (as defined in Rule 12b-2 of the Exchange Act) Yes ¨ No x
As of August 1, 2008, Carrols Restaurant Group, Inc. had 21,573,809 shares of its common stock, $.01 par value, outstanding. As of August 1, 2008, all outstanding equity securities of Carrols Corporation, which consisted of 10 shares of its common stock, were owned by Carrols Restaurant Group, Inc.
QUARTER ENDED JUNE 30, 2008
Carrols Restaurant Group, Inc. and Subsidiary - Consolidated Financial Statements (unaudited):
Consolidated Balance Sheets as of June 30, 2008 and December 31, 2007
Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2008 and 2007
Consolidated Statements of Cash Flows for the Six Months ended June 30, 2008 and 2007
Notes to Consolidated Financial Statements
Carrols Corporation and Subsidiaries - Consolidated Financial Statements (unaudited):
Management’s Discussion and Analysis of Financial Condition and Results of Operations 39
Quantitative and Qualitative Disclosures About Market Risk 54
Controls and Procedures 54
Legal Proceedings 54
Unregistered Sales of Equity Securities and Use of Proceeds 54
Default Upon Senior Securities 54
Submission of Matters to a Vote of Security Holders 54
Other Information 55
Exhibits 55
PART I—FINANCIAL INFORMATION
ITEM 1—INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
CARROLS RESTAURANT GROUP, INC. AND SUBSIDIARY
(In thousands of dollars, except share and per share amounts)
Trade and other receivables
Prepaid rent
Franchise rights, net (Note 4)
Goodwill (Note 4)
Intangible assets, net
Franchise agreements, at cost less accumulated amortization of $5,681 and $5,646, respectively
$ 473,581 $ 465,558
LIABILITIES AND STOCKHOLDERS’ DEFICIT
Current portion of long-term debt (Note 5)
Accrued interest
Accrued payroll, related taxes and benefits
Accrued income taxes payable
Accrued real estate taxes
Long-term debt, net of current portion (Note 5)
Lease financing obligations (Note 9)
Deferred income—sale-leaseback of real estate
Accrued postretirement benefits (Note 8)
Other liabilities (Note 7)
Stockholders’ deficit:
Preferred stock, par value $.01; authorized 20,000,000 shares, issued and outstanding—none
Voting common stock, par value $.01; authorized 100,000,000 shares, issued and outstanding—21,571,871 and 21,571,565 shares, respectively
(625 ) (1,591 )
(1,977 ) (6,680 )
(141 ) (141 )
Total stockholders’ deficit
Total liabilities and stockholders’ deficit
The accompanying notes are an integral part of these unaudited consolidated financial statements.
THREE AND SIX MONTHS ENDED JUNE 30, 2008 AND 2007
Three months ended June 30, Six months ended June 30,
$ 210,331 $ 200,117 $ 405,724 $ 387,983
210,682 200,449 406,435 388,652
63,943 57,375 121,572 109,669
Restaurant wages and related expenses (including stock-based compensation expense of $57, $39, $114 and $76, respectively)
11,568 10,907 23,051 21,586
9,224 8,449 17,048 16,984
General and administrative (including stock-based compensation expense of $435, $315, $852 and $633, respectively)
Impairment losses (Note 3)
Other income (Note 10)
(119 ) — (119 ) (347 )
Loss (gain) on extinguishment of debt (Note 5)
(180 ) — (180 ) 1,485
Income before income taxes
5,137 7,760 7,396 10,229
Provision for income taxes (Note 6)
$ 3,257 $ 5,098 $ 4,703 $ 6,675
Basic and diluted net income per share (Note 13)
$ 0.15 $ 0.24 $ 0.22 $ 0.31
Basic weighted average common shares outstanding (Note 13)
21,571,652 21,550,827 21,571,609 21,550,827
Diluted weighted average common shares outstanding (Note 13)
SIX MONTHS ENDED JUNE 30, 2008 AND 2007
(In thousands of dollars)
Cash flows provided from operating activities:
Adjustments to reconcile net income to net cash provided from operating activities:
Loss (gain) on disposals of property and equipment
(12 ) 109
(1,044 ) (969 )
Loss (gain) on settlements of lease financing obligations
31 (163 )
249 (210 )
Accrued income taxes
Loss (gain) on extinguishment of debt
(180 ) 1,485
Changes in other operating assets and liabilities
(2,203 ) 2,524
Net cash provided from operating activities
Cash flows used for investing activities:
Capital expenditures:
(16,385 ) (18,720 )
Other restaurant capital expenditures
Properties purchased for sale-leaseback
— (2,461 )
Proceeds from sale-leaseback transactions
Proceeds from sales of other properties
Net cash used for investing activities
Cash flows provided from (used for) financing activities:
Repayment of term loans under prior credit facility
— (118,400 )
Borrowings on revolving credit facility
Repayments on revolving credit facility
Proceeds from new senior credit facility
Principal payments on capital leases
(71 ) (205 )
Expenses from initial public offering
— (21 )
Financing costs associated with issuance of debt
Repurchase of senior subordinated notes
(1,820 ) —
Settlement of lease financing obligations
2,109 (4,266 )
Net decrease in cash and cash equivalents
Supplemental disclosures:
Interest paid on long-term debt
$ 11,596 $ 12,912
Interest paid on lease financing obligations
Increase in accruals for capital expenditures
Income taxes paid (refunded), net
$ 1,414 $ (195 )
Capital lease obligations incurred
$ 117 $ —
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands of dollars except share and per share amounts)
1. Basis of Presentation
Basis of Consolidation. The unaudited consolidated financial statements presented herein include the accounts of Carrols Restaurant Group, Inc. (“Carrols Restaurant Group” or the “Company”) and its wholly-owned subsidiary Carrols Corporation (“Carrols”). Carrols Restaurant Group is a holding company and conducts all of its operations through Carrols and its wholly-owned subsidiaries. Unless the context otherwise requires, Carrols Restaurant Group, Carrols and the direct and indirect subsidiaries of Carrols are collectively referred to as the “Company.” All intercompany transactions have been eliminated in consolidation.
The difference between the consolidated financial statements of Carrols Restaurant Group and Carrols is primarily due to additional rent expense of approximately $6 per year for Carrols Restaurant Group and the composition of stockholders’ deficit.
Business Description. At June 30, 2008 the Company operated, as franchisee, 319 quick-service restaurants under the trade name “Burger King” in 12 Northeastern, Midwestern and Southeastern states. At June 30, 2008, the Company also owned and operated 88 Pollo Tropical restaurants, of which 85 were located in Florida and three were located in New Jersey, and franchised a total of 27 Pollo Tropical restaurants, 23 in Puerto Rico, two in Ecuador and two on college campuses in Florida. At June 30, 2008, the Company owned and operated 150 Taco Cabana restaurants located primarily in Texas and franchised two Taco Cabana restaurants in New Mexico and one in Georgia.
Fiscal Year. The Company uses a 52-53 week fiscal year ending on the Sunday closest to December 31. All references herein to the fiscal years ended December 30, 2007 and December 31, 2006 will be referred to as the fiscal years ended December 31, 2007 and 2006, respectively. Similarly, all references herein to the three and six months ended June 29, 2008 and July 1, 2007 will be referred to as the three and six months ended June 30, 2008 and June 30, 2007, respectively. The years ended December 31, 2007 and 2006 each contained 52 weeks and the three and six months ended June 30, 2008 and 2007 contained thirteen and twenty-six weeks, respectively.
Basis of Presentation. The accompanying unaudited consolidated financial statements for the three and six months ended June 30, 2008 and 2007 have been prepared without an audit, pursuant to the rules and regulations of the Securities and Exchange Commission and do not include certain of the information and the footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all normal and recurring adjustments considered necessary for a fair presentation of such financial statements have been included. The results of operations for the three and six months ended June 30, 2008 and 2007 are not necessarily indicative of the results to be expected for the full year.
These unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2007 contained in the Company’s 2007 Annual Report on Form 10-K. The December 31, 2007 balance sheet data is derived from those audited financial statements.
Reclassification of previously issued interim financial statements. The Company has reclassified certain prior year amounts related to its Pollo Tropical restaurant expenses from cost of sales to other restaurant operating expenses in order to conform to the 2008 presentation in the Company’s interim results of operations and the presentation in the Company’s 2007 Annual Report on Form 10-K. The amount of increase (decrease) in previously reported interim amounts was as follows:
June 30, 2007 Six Months Ended
$ (264 ) $ (527 )
$ — $ —
Use of Estimates. The preparation of the financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Significant items subject to such estimates include: accrued occupancy costs, insurance liabilities, legal obligations, income taxes, evaluation for impairment of goodwill, long-lived assets and Burger King franchise rights, lease accounting matters and stock-based compensation. Actual results could differ from those estimates.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
2. Stock-Based Compensation
The Company adopted an incentive stock plan in 2006 (the “2006 Plan”) under which incentive stock options, non-qualified stock options and restricted shares may be granted to employees and non-employee directors.
On January 15, 2008, the Company granted options to purchase 517,820 shares of its common stock, consisting of 160,000 shares of non-qualified stock options and 357,820 shares of incentive stock options (“ISOs”), and issued 7,100 shares of restricted stock. The non-qualified stock options and ISOs granted are exercisable for up to one-fifth of the total number of option shares on or after the first anniversary of the grant date and as of the first day of each month thereafter are exercisable for an additional one-sixtieth of the total number of option shares until fully exercisable. The options expire seven years from the date of the grant and were issued with an exercise price equal to the fair market value of the stock price, or $8.08 per share of common stock, on the date of grant. The restricted stock awards vest 100% on the third anniversary of the award date.
During the three months ended June 30, 2008 an aggregate of 10,500 non-qualified stock options were granted to three non-employee directors under the 2006 Plan. The options were issued with an exercise price equal to the fair market value of the stock price, or $6.43 per share of common stock, on the date of grant and generally vest 20% per year. During the three months ended June 30, 2007, there were an aggregate of 1,000 restricted shares granted to certain employees and an aggregate of 10,500 non-qualified options granted to three non-employee directors under the 2006 Plan. The stock options granted to the non-employee directors vest 20% per year and the restricted shares granted to employees vest 33% per year.
The Company currently uses and will continue to use the simplified method to estimate the expected term for share option grants until it has enough historical experience to provide a reasonable estimate of expected term in accordance with Staff Accounting Bulletin No. 110 (“SAB 110”). The weighted average fair-value of options granted during the three months ended June 30, 2008 was $1.96 which was estimated using the Black-Scholes option pricing model with the following weighted-average assumptions:
Risk-free interest rate
Annual dividend yield
Expected term
Expected volatility
Stock-based compensation expense for the three and six months ended June 30, 2008 was $0.5 million and $1.0 million, respectively and for the three and six months ended June 30, 2007 was $0.4 million and $0.7 million, respectively.
As of June 30, 2008, the total non-vested stock-based compensation expense relating to the options and restricted shares is approximately $4.7 million and the Company expects to record an additional $1.0 million as compensation expense in 2008. The remaining weighted average vesting period for the stock options is 3.89 years and restricted shares is approximately 2.18 years at June 30, 2008.
A summary of all option activity for the six months ended June 30, 2008 was as follows:
Options Weighted
Exercise Price Average
Life Aggregate
Value (in
thousands)
Options outstanding at January 1, 2008
1,214,690 $ 14.31 6.0 $ —
528,320 8.05
(42,712 ) 11.95
Options outstanding at June 30, 2008
Expected to vest at June 30, 2008
Options exercisable at June 30, 2008
358,059 $ 14.31 5.5 $ —
(1) The aggregate intrinsic value was calculated using the difference between the market price of the Company’s common stock at June 30, 2008 and the grant price for only those awards that have a grant price that is less than the market price of the Company’s common stock at June 30, 2008.
Restricted Shares
The restricted stock activity for the six months ended June 30, 2008 was as follows:
Shares Weighted
Grant Date
Nonvested at January 1, 2008
55,398 $ 13.22
Shares granted
7,100 8.08
Shares vested
(306 ) 16.00
Shares forfeited
(2,664 ) 12.86
Nonvested at June 30, 2008
59,528 12.60
The value of restricted shares is determined based on the Company’s closing price on the date of grant.
3. Impairment of Long-Lived Assets
The Company reviews its long-lived assets, principally property and equipment, for impairment at the restaurant level. If an indicator of impairment exists for any of its assets, an estimate of undiscounted future cash flows from the related long-lived assets is compared to that long-lived asset’s carrying value. If the carrying value is greater than the undiscounted cash flow, the Company then determines the fair value of the asset. If an asset is determined to be impaired, the loss is measured by the excess of the carrying amount of the asset over its fair value.
For the three and six months ended June 30, 2008 and 2007, the Company recorded impairment losses on long-lived assets for its segments as follows:
June 30, Six Months Ended
$ 71 $ 14 $ 92 $ 14
$ 81 $ 69 $ 102 $ 69
4. Goodwill and Franchise Rights
Goodwill. Goodwill is reviewed for impairment annually, or more frequently when events and circumstances indicate that the carrying amounts may be impaired. The Company performs its annual impairment assessment as of December 31 and does not believe circumstances have changed since the last assessment date which would make it necessary to reassess their values. Goodwill balances are summarized below:
Tropical Taco
Cabana Burger
King Total
Balance, June 30, 2008
$ 56,307 $ 67,177 $ 1,450 $ 124,934
Burger King Franchise Rights. Amounts allocated to franchise rights for each Burger King acquisition are amortized using the straight-line method over the average remaining term of the acquired franchise agreements at January 1, 2002 plus one twenty-year renewal period. The Company assesses the potential impairment of franchise rights whenever events or changes in circumstances indicate that the carrying value may not be recoverable. If an indicator of impairment exists, an estimate of the aggregate undiscounted future cash flows from the acquired restaurants is compared to the respective carrying value of franchise
rights for each Burger King acquisition. If an asset is determined to be impaired, the loss is measured by the excess of the carrying amount of the asset over its fair value. There were no impairment charges recorded against franchise rights for the three and six months ended June 30, 2008 and 2007.
Amortization expense related to Burger King franchise rights was $799 and $804 for the three months ended June 30, 2008 and 2007, respectively. Amortization expense related to Burger King franchise rights was $1,600 and $1,608 for the six months ended June 30, 2008 and 2007. The estimated amortization expense for the year ending December 31, 2008 is $3,197 and for each of the five succeeding years is $3,196.
5. Long-term Debt
Long-term debt at June 30, 2008 and December 31, 2007 consisted of the following:
Collateralized:
Revolving Credit facility
$ 9,500 $ —
Senior Credit Facility-Term loan A facility
Unsecured:
9% Senior Subordinated Notes
Less: current portion
On March 9, 2007, Carrols terminated and replaced its prior senior credit facility with a new senior credit facility with a syndicate of lenders. Carrols’ credit facility totals approximately $185 million, consisting of $120 million principal amount of term loan A borrowings maturing on March 8, 2013 (or earlier on September 30, 2012 if the 9% Senior Subordinated Notes due 2013 are not refinanced by June 30, 2012) and a $65.0 million revolving facility (including a sub limit of up to $25.0 million for letters of credit and up to $5.0 million for swingline loans), maturing on March 8, 2012. The term loan A borrowings and an additional $4.3 million of revolver borrowings from this facility were used to repay all outstanding borrowings and other obligations under the Carrols’ prior senior credit facility and to pay certain fees and expenses incurred in connection with the new senior credit facility. The Company also recorded a $1.5 million loss on extinguishment of debt in the six months ended June 30, 2007 for the write-off of deferred financing costs related to the prior senior credit facility.
The term loan and revolving credit borrowings under the senior credit facility bear interest at a per annum rate, at Carrols’ option, of either:
1) the applicable margin ranging from 0% to 0.25% based on Carrols’ senior leverage ratio (as defined in the new senior credit facility) plus the greater of (i) the prime rate or (ii) the federal funds rate for that day plus 0.5%; or
2) Adjusted LIBOR plus the applicable margin percentage in effect ranging from 1.0% to 1.5% based on Carrols’ senior leverage ratio.
Term loan A borrowings shall be due and payable in quarterly installments, beginning on June 30, 2008 as follows:
1) four quarterly installments of $1.5 million beginning on June 30, 2008;
2) eight quarterly installments of $3.0 million beginning on June 30, 2009;
3) four quarterly installments of $4.5 million beginning on June 30, 2011; and
4) four quarterly installments of $18.0 million beginning on June 30, 2012.
Under the senior credit facility, Carrols is also required to make mandatory prepayments of principal on term loan A facility borrowings (a) annually in an initial amount equal to 50% of Excess Cash Flow depending upon Carrols’ Total Leverage Ratio (as such terms are defined in the senior credit facility), (b) in the event of certain dispositions of assets (all subject to certain exceptions) and insurance proceeds, in an amount equal to 100% of the net proceeds received by Carrols therefrom, and (c) in an amount equal to 100% of the net proceeds from any subsequent issuance of debt.
In general, Carrols’ obligations under the senior credit facility are guaranteed by the Company and all of Carrols’ material subsidiaries and are collateralized by a pledge of Carrols’ common stock and the stock of each of Carrols’ material subsidiaries. The senior credit facility contains certain covenants, including, without limitation, those limiting the Carrols’ ability to incur indebtedness, incur liens, sell or acquire assets or businesses, change the nature of its business, engage in transactions with related parties, make certain investments or pay dividends. In addition, Carrols is required to meet certain financial ratios, including fixed charge coverage, senior leverage, and total leverage ratios (all as defined under the senior credit facility). Carrols was in compliance with the covenants under its senior credit facility as of June 30, 2008.
At June 30, 2008, $120.0 million principal amount of term loan borrowings were outstanding under the term loan A facility and $9.5 million principal amount of borrowings were outstanding under the revolving credit facility. After reserving $14.2 million for letters of credit guaranteed by the facility, $41.3 million was available for borrowings under the revolving credit facility at June 30, 2008.
On December 15, 2004, Carrols issued $180 million of 9% Senior Subordinated Notes due 2013, which are referred to herein as the “senior subordinated notes”. Restrictive covenants under the senior subordinated notes include limitations with respect to the Carrols’ ability to issue additional debt, incur liens, sell or acquire assets or businesses, pay dividends and make certain investments. On April 7, 2008, Carrols purchased and retired $2.0 million of its senior subordinated notes in an open market transaction. This resulted in a gain on extinguishment of debt of $0.2 million in the three months ended June 30, 2008. At June 30, 2008 and December 31, 2007, $178.0 million and $180.0 million principal amount of the senior subordinated notes were outstanding, respectively.
The provision for income taxes for the three and six months ended June 30, 2008 and 2007 was comprised of the following:
(65 ) (210 ) 249 (210 )
The provision for income taxes for the three and six months ended June 30, 2008 was derived using an estimated effective annual income tax rate for 2008 of 37.9%, which excludes any discrete tax adjustments. Discrete tax adjustments reduced the provision for income taxes by $66 and $112 for the three and six months ended June 30, 2008.
The provision for income taxes for the three and six months ended June 30, 2007 was derived using an estimated effective annual income tax rate for 2007 of 36.0%. The tax provision for the three and six months ended June 30, 2007 includes a reduction of tax expense of $0.4 million related to the recognition of additional employment tax credits, $0.2 million of additional tax expense related to a New York state income tax audit assessment and $0.1 million of additional tax expense associated with changes in New York state tax legislation enacted in the second quarter of 2007. The net reduction of income tax expense of $0.1 million for these items was recorded in the second quarter.
The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. As of June 30, 2008, the Company had no unrecognized tax benefits and no accrued interest related to uncertain tax positions.
The tax years 2004-2007 remain open to examination by the major taxing jurisdictions to which the Company is subject. It is not possible to reasonably estimate any possible change in the unrecognized tax benefits within the next twelve months.
7. Other Liabilities, Long-Term
Other liabilities, long-term, at June 30, 2008 and December 31, 2007 consisted of the following:
Unearned purchase discounts
Accrued occupancy costs
10,229 9,667
Accrued workers’ compensation costs
In 2001, management decided to close seven Taco Cabana restaurants in the Phoenix, Arizona market and discontinue restaurant development underway in that market. At both June 30, 2008 and December 31, 2007, the Company had $0.5 million in lease liability reserves for remaining locations that are included in accrued occupancy costs.
8. Postretirement Benefits
The Company provides postretirement medical and life insurance benefits covering substantially all Burger King administrative and restaurant management salaried employees. A December 31 measurement date is used for postretirement benefits. On November 1, 2007 the Company amended its postretirement medical and life insurance benefits to eliminate life insurance benefits for active employees who retire after December 31, 2007 and to increase retiree contributions for both current and future retirees effective January 1, 2008. These amendments reduced the Company’s postretirement benefit obligations and reduced expense in the three and six months ended June 30, 2008.
The following summarizes the components of net periodic benefit cost:
$ (24 ) $ 128 $ 14 $ 246
Interest cost
(18 ) 110 53 203
Amortization of gains and losses
Amortization of unrecognized prior service cost
(67 ) 10 (180 ) 3
Net periodic postretirement benefit cost (benefit)
$ (106 ) $ 279 $ (69 ) $ 500
During the three and six months ended June 30, 2008, the Company made contributions of $31 and $80 to its postretirement plan.
9. Lease Financing Obligations
The Company entered into sale-leaseback transactions in various years involving certain restaurant properties that did not qualify for sale-leaseback accounting and as a result, have been classified as financing transactions under Statement of Financial Accounting Standards (“SFAS”) No. 98, “Accounting for Leases” (“SFAS 98”). Under the financing method, the assets remain on the consolidated balance sheet and proceeds received by the Company from these transactions are recorded as a financing liability. Payments under these leases are applied as payments of imputed interest and deemed principal on the underlying financing obligations.
In the second quarter of 2008, the Company purchased from the lessor six restaurant properties for $5.5 million that were previously accounted for as lease financing obligations. As a result, the Company reduced its lease financing obligations by $5.5 million and recorded a loss of $31 as an increase to interest expense which represented the amount by which the purchase price exceeded the lease financing obligations.
In the second quarter of 2007, the Company exercised its right of first refusal under the leases for five restaurant properties previously accounted for as lease financing obligations and purchased these properties from the lessor. As a result, the Company reduced its lease financing obligations by $4.4 million. The Company also recorded a gain of $0.2 million as a reduction of interest expense which represented the net amount by which the lease financing obligations exceeded the purchase price of the acquired restaurant properties.
Interest expense associated with lease financing obligations, including settlement gains and losses, for the three months ended June 30, 2008 and 2007 was $1.4 million and $1.3 million, respectively, and for the six months ended June 30, 2008 and 2007 was $2.7 million and $2.8 million, respectively.
10. Other Income
The Company recorded a gain of $0.1 million in the three and six months ended June 30, 2008 and a gain of $0.3 million in the six months ended June 30, 2007 each related to the sale of a Taco Cabana property.
11. Business Segment Information
The Company is engaged in the quick-service and quick-casual restaurant industry, with three restaurant concepts: Burger King operating as a franchisee and Pollo Tropical and Taco Cabana, both Company-owned concepts. The Company’s Burger King restaurants are all located in the United States, primarily in the Northeast, Southeast and Midwest. Pollo Tropical is a quick-casual restaurant chain featuring grilled marinated chicken and Caribbean style “made from scratch” side dishes. Pollo Tropical’s core markets are located in South and Central Florida. Taco Cabana is a quick-casual restaurant chain featuring fresh Mexican style food, including flame-grilled beef and chicken fajitas, quesadillas and other Tex-Mex dishes. Taco Cabana’s core markets are primarily located in Texas.
The accounting policies of each segment are the same as those described in the summary of significant accounting policies. The following table includes Segment EBITDA which is the measure of segment profit or loss reported to the chief operating decision maker for purposes of allocating resources to the segments and assessing their performance. Segment EBITDA is defined as earnings attributable to the applicable segment before interest, income taxes, depreciation and amortization, impairment losses, stock-based compensation expense, other income and expense and loss (gain) on extinguishment of debt.
The “Other” column includes corporate related items not allocated to reportable segments, including stock-based compensation expense. Other identifiable assets consist primarily of cash, certain other assets, corporate property and equipment including restaurant information systems expenditures, goodwill and deferred income taxes.
King Other Consolidated
June 30, 2008:
$ 45,404 $ 63,436 $ 101,842 $ — $ 210,682
15,312 19,540 29,091 — 63,943
10,899 18,594 31,213 57 60,763
General and administrative expenses (1)
2,762 3,006 7,514 435 13,717
2,000 2,091 3,611 375 8,077
Segment EBITDA
Capital expenditures, including acquisitions
4,862 6,158 3,479 1,881 16,380
$ 42,747 $ 60,774 $ 96,928 $ — $ 200,449
$ 89,736 $ 123,693 $ 193,006 $ — $ 406,435
29,653 38,376 53,543 — 121,572
22,199 36,244 60,747 114 119,304
5,328 6,012 14,520 852 26,712
11,408 9,040 6,196 2,585 29,229
20,965 33,874 59,595 76 114,510
Identifiable Assets:
$ 66,924 $ 81,209 $ 147,460 $ 177,988 $ 473,581
59,609 79,370 148,467 178,112 465,558
(1) For the Pollo Tropical and Taco Cabana segments, such amounts include general and administrative expenses related directly to each segment. For the Burger King segment such amounts include general and administrative expenses related directly to the Burger King segment as well as expenses associated with administrative support to all three of the Company’s segments including executive management, information systems and certain accounting, legal and other administrative functions.
A reconciliation of segment EBITDA to consolidated net income is as follows:
Segment EBITDA:
$ 6,733 $ 7,254 $ 12,737 $ 14,086
Less:
Provision for income taxes
On November 16, 1998, the Equal Employment Opportunity Commission (“EEOC”) filed suit in the United States District Court for the Northern District of New York (the “Court”), under Title VII of the Civil Rights Act of 1964, as amended, against Carrols. The complaint alleged that Carrols engaged in a pattern and practice of unlawful discrimination, harassment and retaliation against former and current female employees. The EEOC identified approximately 450 individuals (which were subsequently increased to 511 individuals) that it believed represented the class of claimants and was seeking monetary and injunctive relief from Carrols. On April 20, 2005, the Court issued a decision and order granting Carrols’ Motion for Summary Judgment that Carrols filed in January 2004. Subject to possible appeal by the EEOC, the case is dismissed; however the Court noted that it was not ruling on the claims, if any, that individual employees might have against Carrols. On February 27, 2006, Carrols filed a motion for summary judgment to dismiss all but between four and 17 of the individual claims. On July 10, 2006, in its response to that motion, the EEOC asserted that, notwithstanding the Court’s dismissal of the case as a class action, the EEOC may still maintain some kind of collective action on behalf of these claimants. Oral argument before the Court was held on October 4, 2006 and the Company is awaiting the Court’s decision on Carrols’ summary judgment motion. The Company does not believe that any individual claim, if any, would have a material adverse impact on its consolidated financial statements. Although the Company believes that the EEOC’s continued class litigation argument is without merit, it is not possible to predict the outcome of the pending motion.
On November 30, 2002, four former hourly employees commenced a lawsuit against Carrols in the United States District Court for the Western District of New York (the “Court”) entitled Dawn Seever, et al. v. Carrols Corporation. The lawsuit alleged, in substance, that Carrols violated certain minimum wage laws under the Federal Fair Labor Standards Act and related state laws by requiring employees to work without recording their time and by retaliating against those who complained. The plaintiffs sought damages, costs and injunctive relief. They also sought to notify and certify, a class consisting of current and former employees who, since 1998, have worked, or are working, for Carrols. On December 17, 2007, the Court issued a decision and order denying Plaintiffs’ motion for notice and class certification and granting the Company’s motion to dismiss all of the claims of the plaintiffs, other than certain nominal claims relating to orientation and managers’ meetings. The Court instructed the parties to confer, in good faith, and settle those nominal claims. Subject to settlement of the amounts for orientation and managers’ meetings and possible appeal by the Plaintiffs, the case is concluded. The Company does not believe that these settlement amounts will be material to its consolidated financial statements.
The Company is a party to various other litigation matters incidental to the conduct of business. The Company does not believe that the outcome of any of these other matters will have a material adverse effect on its consolidated financial statements.
13. Net Income Per Share
Basic net income per share is computed by dividing net income for the period by the weighted average number of common shares outstanding during the period. Diluted net income per share is computed by dividing net income for the period by the weighted average number of common shares outstanding plus the dilutive effect of outstanding stock options using the treasury stock method.
The computation of diluted net income per share excludes options to purchase 1,099,544 and 631,375 shares of common stock for each of the three and six months ended June 30, 2008 and 2007, respectively, because the exercise price of these options was greater than the average market price of the common shares in the periods and therefore, they were antidilutive. In addition, options to purchase 2,538 and 620,875 shares of common stock are excluded from the computation of diluted net income per share in each of the three and six months ended June 30, 2008 and 2007, respectively, as they were antidilutive under the treasury stock method.
The following table is a reconciliation of the income and share amounts used in the calculation of basic net income per share and diluted net income per share:
Basic net income per share:
Basic net income per share
Diluted net income per share:
Net income for diluted net income per share
Shares used in computed basic net income per share
Dilutive effect of restricted shares and stock options
3,753 14,381 3,216 10,968
Shares used in computed diluted net income per share
Diluted net income per share
14. Comprehensive income
SFAS No. 130, “Reporting Comprehensive Income” (“SFAS 130”), requires the disclosure of certain revenue, expenses, gains and losses that are excluded from net income in accordance with U.S. generally accepted accounting principles. The items that currently impact the Company’s other comprehensive income are changes in postretirement benefit obligations, net of tax.
Change in postretirement benefit obligation, net of tax
— — 8 —
Comprehensive income
15. Recent Accounting Developments
In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). This statement defines fair value, establishes a framework for using fair value to measure assets and liabilities and expands disclosures about fair value measurements. The statement applies whenever other pronouncements require or permit assets or liabilities to be measured at fair value. In February 2007, the FASB issued FSP FAS 157-2, delaying the effective date of SFAS 157 for certain nonfinancial assets and liabilities to fiscal years beginning after November 15, 2008. The implementation of SFAS 157 for financial assets and financial liabilities, effective for fiscal 2008, did not have a material impact on the Company’s consolidated financial statements. The Company is currently evaluating the impact SFAS 157 may have for nonfinancial assets and liabilities in its consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Liabilities – Including an Amendment of FASB Statement No. 115” (“SFAS 159”). This statement permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS 159 is effective for the Company’s fiscal year beginning January 1, 2008. The Company did not elect to begin reporting any financial assets or liabilities at fair value upon adoption of this standard.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financials Statements, an Amendment of ARB No. 51” (“SFAS 160”). SFAS 160 clarifies the accounting for non controlling interests and establishes accounting and reporting standards for the noncontrolling interest in a subsidiary, including classification as a component of equity. SFAS 160 is effective for fiscal years beginning after December 15, 2008. The Company is currently evaluating the impact SFAS 160 will have on its consolidated financial statements.
In April 2008, the FASB issued FSP SFAS No. 142-3 “Determination of the Useful Life of Intangible Assets” (“SFAS 142-3”). SFAS 142-3 amends the factors that should be considered in developing renewal or extension assumption used to determine the useful life of a recognized intangible asset under SFAS No. 142. The requirement for determining useful lives must be applied prospectively to intangible assets acquired after the effective date and the disclosure requirements applied prospectively to all intangible assets recognized as of, and subsequent to, the effective date. SFAS No. 142-3 is effective for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years, which will require the Company to adopt these provisions in the first quarter of 2009. The Company has reviewed this pronouncement and does not anticipate the adoption of SFAS No. 142-3 will materially impact its financial statements.
CARROLS CORPORATION AND SUBSIDIARIES
Common stock, par value $1; authorized 1,000 shares, issued and outstanding—10 shares at both dates
Accumulated earnings
Basis of Consolidation. The unaudited consolidated financial statements presented herein include the accounts of Carrols Corporation and its subsidiaries (“the Company”). The Company is a wholly-owned subsidiary of Carrols Restaurant Group, Inc. (“Carrols Restaurant Group” or the “Parent Company”). All intercompany transactions have been eliminated in consolidation.
The difference between the consolidated financial statements of Carrols Corporation and Carrols Restaurant Group is primarily due to additional rent expense of approximately $6 per year for Carrols Restaurant Group and the composition of stockholder’s deficit.
Business Description. At June 30, 2008 the Company operated, as franchisee, 319 quick-service restaurants under the trade name “Burger King” in 12 Northeastern, Midwestern and Southeastern states. At June 30, 2008, the Company also owned and operated 88 Pollo Tropical restaurants of which 85 were located in Florida and three were located in New Jersey, and franchised a total of 27 Pollo Tropical restaurants, 23 in Puerto Rico, two in Ecuador and two on college campuses in Florida. At June 30, 2008, the Company owned and operated 150 Taco Cabana restaurants located primarily in Texas and franchised two Taco Cabana restaurants in New Mexico and one in Georgia.
Earnings Per Share Presentation. The guidance of Statement of Financial Accounting Standards (“SFAS”) No. 128, “Earnings Per Share,” requires presentation of earnings per share by all entities that have issued common stock or potential common stock if those securities trade in a public market either on a stock exchange (domestic or foreign) or in the over-the-counter market. The Company’s common stock is not publicly traded and therefore, earnings per share amounts are not presented.
Carrols Restaurant Group adopted an incentive stock plan in 2006 (the “2006 Plan”) under which incentive stock options, non-qualified stock options and restricted shares may be granted to employees and non-employee directors.
On January 15, 2008, Carrols Restaurant Group granted options to purchase 517,820 shares of its common stock, consisting of 160,000 shares of non-qualified stock options and 357,820 shares of incentive stock options (“ISOs”), and issued 7,100 shares of restricted stock. The non-qualified stock options and ISOs granted are exercisable for up to one-fifth of the total number of option shares on or after the first anniversary of the grant date and as of the first day of each month thereafter are exercisable for an additional one-sixtieth of the total number of option shares until fully exercisable. The options expire seven years from the date of the grant and were issued with an exercise price equal to the fair market value of the stock price, or $8.08 per share of common stock, on the date of grant. The restricted stock awards vest 100% on the third anniversary of the award date.
During the three months ended June 30, 2008 an aggregate of 10,500 non-qualified stock options were granted to three non-employee directors under the 2006 Plan. The options were issued with an exercise price equal to the fair market value of the stock price, or $6.43 per share of common stock, on the date of grant and generally vest 20% per year. During the three months ended June 30, 2007, there were an aggregate of 1,000 restricted shares granted to certain employees and an aggregate of 10,500 non-qualified stock options granted to three non-employee directors under the 2006 Plan. The stock options granted to the non-employee directors vest 20% per year and the restricted shares granted to employees vest 33% per year.
thousands) (1)
(1) The aggregate intrinsic value was calculated using the difference between the market price of Carrols Restaurant Group’s common stock at June 30, 2008 and the grant price for only those awards that have a grant price that is less than the market price of Carrols Restaurant Group’s common stock at June 30, 2008.
The value of restricted shares is determined based on Carrols Restaurant Group’s closing price on the date of grant.
For the three and six months ended June 30, 2008, the Company recorded impairment losses on long-lived assets for its segments as follows:
Three Months Ended Six Months Ended
June 30, June 30,
Burger King Franchise Rights. Amounts allocated to franchise rights for each Burger King acquisition are amortized using the straight-line method over the average remaining term of the acquired franchise agreements at January 1, 2002 plus one twenty-year renewal period. The Company assesses the potential impairment of franchise rights whenever events or changes in circumstances indicate that the carrying value may not be recoverable. If an indicator of impairment exists, an estimate of the aggregate undiscounted future cash flows from the acquired restaurants is compared to the respective carrying value of franchise rights for each Burger King acquisition. If an asset is determined to be impaired, the loss is measured by the excess of the carrying amount of the asset over its fair value. There were no impairment charges recorded against franchise rights for the three and six months ended June 30, 2008 and 2007.
On March 9, 2007, the Company terminated and replaced its prior senior credit facility with a new senior credit facility with a syndicate of lenders. The Company’s credit facility totals approximately $185 million, consisting of $120 million principal amount of term loan A borrowings maturing on March 8, 2013 (or earlier on September 30, 2012 if the 9% Senior Subordinated Notes due 2013 are not refinanced by June 30, 2012) and a $65.0 million revolving facility (including a sub limit of up to $25.0 million for letters of credit and up to $5.0 million for swingline loans), maturing on March 8, 2012. The term loan A borrowings and an additional $4.3 million of revolver borrowings from this facility were used to repay all outstanding borrowings and other obligations under the Company’s prior senior credit facility and to pay certain fees and expenses incurred in connection with the new senior credit facility. The Company also recorded a $1.5 million loss on extinguishment of debt in the six months ended June 30, 2007 for the write-off of deferred financing costs related to the prior senior credit facility.
The term loan and revolving credit borrowings under the senior credit facility bear interest at a per annum rate, at the Company’s option, of either:
1) the applicable margin ranging from 0% to 0.25% based on the Company’s senior leverage ratio (as defined in the new senior credit facility) plus the greater of (i) the prime rate or (ii) the federal funds rate for that day plus 0.5%; or
2) Adjusted LIBOR plus the applicable margin percentage in effect ranging from 1.0% to 1.5% based on the Company’s senior leverage ratio.
Under the senior credit facility, the Company is also required to make mandatory prepayments of principal on term loan A facility borrowings (a) annually in an initial amount equal to 50% of Excess Cash Flow depending upon the Company’s Total Leverage Ratio (as such terms are defined in the senior credit facility), (b) in the event of certain dispositions of assets (all subject to certain exceptions) and insurance proceeds, in an amount equal to 100% of the net proceeds received by the Company therefrom, and (c) in an amount equal to 100% of the net proceeds from any subsequent issuance of debt.
In general, the Company’s obligations under the senior credit facility are guaranteed by Carrols Restaurant Group and all of the Company’s material subsidiaries and are collateralized by a pledge of the Company’s common stock and the stock of each of the Company’s material subsidiaries. The senior credit facility contains certain covenants, including, without limitation, those limiting the Company’s ability to incur indebtedness, incur liens, sell or acquire assets or businesses, change the nature of its business, engage in transactions with related parties, make certain investments or pay dividends. In addition, the Company is required to meet certain financial ratios, including fixed charge coverage, senior leverage, and total leverage ratios (all as defined under the senior credit facility). The Company was in compliance with the covenants under its new senior credit facility as of June 30, 2008.
On December 15, 2004, the Company issued $180 million of 9% Senior Subordinated Notes due 2013, which are referred to herein as the “senior subordinated notes.” Restrictive covenants under the senior subordinated notes include limitations with respect to the Company’s ability to issue additional debt, incur liens, sell or acquire assets or businesses, pay dividends and make certain investments. On April 7, 2008, the Company purchased and retired $2.0 million of the senior subordinated notes in an open market transaction. This resulted in a gain on extinguishment of debt of $0.2 million in the three months ended June 30, 2008. At June 30, 2008 and December 31, 2007, $178.0 million and $180.0 million principal amount of the senior subordinated notes were outstanding, respectively.
June 30, December 31,
In 2001, management decided to close seven Taco Cabana restaurants in the Phoenix, Arizona market and discontinue restaurant development underway in that market. At both June 30, 2008 and December 31, 2007, the Company had $0.5 million in lease liability reserves for the remaining locations that are included in accrued occupancy costs.
The Company entered into sale-leaseback transactions in various years involving certain restaurant properties that did not qualify for sale-leaseback accounting and as a result, have been classified as financing transactions under SFAS No. 98, “Accounting for Leases” (“SFAS 98”). Under the financing method, the assets remain on the consolidated balance sheet and proceeds received by the Company from these transactions are recorded as a financing liability. Payments under these leases are applied as payments of imputed interest and deemed principal on the underlying financing obligations.
Interest expense associated with lease financing obligations, including settlement gains and losses, for the three months ended June 30, 2008 and 2007 was $1.4 million and $1.3 million, respectively and for the six months ended June 30, 2008 and 2007 was $2.7 million and $2.8 million, respectively.
(1) For the Pollo Tropical and Taco Cabana segments, such amounts include general and administrative expenses related directly to each segment. For the Burger King segment such amounts include general and administrative expenses related directly to the Burger King segment as well as expenses associated with administrative support to all of the Company’s segments including executive management, information systems and certain accounting, legal and other administrative functions.
On November 16, 1998, the Equal Employment Opportunity Commission (“EEOC”) filed suit in the United States District Court for the Northern District of New York (the “Court”), under Title VII of the Civil Rights Act of 1964, as amended, against the Company. The complaint alleged that the Company engaged in a pattern and practice of unlawful discrimination, harassment and retaliation against former and current female employees. The EEOC identified approximately 450 individuals (which were subsequently increased to 511 individuals) that it believed represented the class of claimants and was seeking monetary and injunctive relief from the Company. On April 20, 2005, the Court issued a decision and order granting the Company’s Motion for Summary Judgment that the Company filed in January 2004. Subject to possible appeal by the EEOC, the case is dismissed; however the Court noted that it was not ruling on the claims, if any, that individual employees might have against the Company. On February 27, 2006, the Company filed a motion for summary judgment to dismiss all but between four and 17 of the individual claims. On July 10, 2006, in its response to that motion, the EEOC asserted that, notwithstanding the Court’s dismissal of the case as a class action, the EEOC may still maintain some kind of collective action on behalf of these claimants. Oral argument before the Court was held on October 4, 2006 and the Company is awaiting the Court’s decision on the Company’ summary judgment motion. The Company does not believe that any individual claim, if any, would have a material adverse impact on its consolidated financial statements. Although the Company believes that the EEOC’s continued class litigation argument is without merit, it is not possible to predict the outcome of the pending motion.
On November 30, 2002, four former hourly employees commenced a lawsuit against the Company in the United States District Court for the Western District of New York (the “Court”) entitled Dawn Seever, et al. v. the Company. The lawsuit alleged, in substance, that the Company violated certain minimum wage laws under the Federal Fair Labor Standards Act and related state laws by requiring employees to work without recording their time and by retaliating against those who complained. The plaintiffs sought damages, costs and injunctive relief. They also sought to notify and certify, a class consisting of current and former employees who, since 1998, have worked, or are working, for the Company. On December 17, 2007, the Court issued a decision and order denying Plaintiffs’ motion for notice and class certification and granting the Company’s motion to dismiss all of the claims of the plaintiffs, other than certain nominal claims relating to orientation and managers’ meetings. The Court instructed the parties to confer, in good faith, and settle those nominal claims. Subject to settlement of the amounts for orientation and managers’ meetings and possible appeal by the Plaintiffs, the case is concluded. The Company does not believe that these settlement amounts will be material to its consolidated financial statements.
SFAS No. 130, “Reporting Comprehensive Income” (“SFAS 130”), requires the disclosure of certain revenue, expenses, gains and losses that are excluded from net income in accordance with U.S. generally accepted accounting principles. The items that currently impact the Company’s other comprehensive income are changes in the postretirement benefit obligations, net of tax.
15. Guarantor Financial Statements
The Company’s obligations under the senior subordinated notes are jointly and severally guaranteed in full on an unsecured senior subordinated basis by certain of the Company’s subsidiaries (“Guarantor Subsidiaries”), all of which are directly or indirectly wholly-owned by the Company. These subsidiaries are:
Cabana Beverages, Inc.
Cabana Bevco LLC
Carrols LLC
Carrols Realty Holdings Corp.
Carrols Realty I Corp.
Carrols Realty II Corp.
Carrols J.G. Corp.
Quanta Advertising Corp.
Pollo Franchise, Inc.
Pollo Operations, Inc.
Taco Cabana, Inc.
TP Acquisition Corp.
TC Bevco LLC
T.C. Management, Inc.
TC Lease Holdings III, V and VI, Inc.
Get Real, Inc.
Texas Taco Cabana, L.P.
TPAQ Holding Corporation
The following supplemental financial information sets forth on a consolidating basis, balance sheets as of June 30, 2008 and December 31, 2007 for the Parent Company only, Guarantor Subsidiaries and for the Company and the related statements of operations and cash flows for the three and six months ended June 30, 2008 and 2007.
For certain of the Company’s sale-leaseback transactions, the Parent Company has guaranteed on an unsecured basis the rental payments of its subsidiaries. In accordance with Emerging Issues Task Force Issue No. 90-14, “Unsecured Guarantee by Parent of Subsidiary’s Lease Payments in a Sale-Leaseback Transaction,” the Company has included in the following guarantor financial statements amounts pertaining to these leases as if they were accounted for as financing transactions of the Guarantor Subsidiaries. These adjustments are eliminated in consolidation.
For purposes of the guarantor financial statements, the Company and its subsidiaries determine the applicable tax provision for each entity generally using the separate return method. Under this method, current and deferred taxes are allocated to each reporting entity as if it were to file a separate tax return. The rules followed by the reporting entity in computing its tax obligation or refund, including the effects of the alternative minimum tax, would be the same as those followed in filing a separate return with the Internal Revenue Service. However, for purposes of evaluating an entity’s ability to realize its tax attributes, the Company assesses whether it is more likely than not that those assets will be realized at the consolidated level. Any differences in the total of the income tax provision for the Parent Company only and the Guarantor Subsidiaries, as calculated on the separate return method and the consolidated income tax provision are eliminated in consolidation.
The Company provides some administrative support to its subsidiaries related to executive management, information systems and certain accounting, legal and other administrative functions. For purposes of the guarantor financial statements, the Company allocates such corporate costs on a specific identification basis, where applicable, or based on revenues or the number of restaurants for each subsidiary. Management believes that these allocations are reasonable based on the nature of costs incurred.
CONSOLIDATING BALANCE SHEET
Only Guarantor
Subsidiaries Eliminations Consolidated
$ 2,028 $ 2,404 $ — $ 4,432
1,225 4,660 — 5,885
12,545 17,540 — 30,085
61,838 205,634 (55,519 ) 211,953
Franchise rights, net
78,469 — — 78,469
1,450 123,484 — 124,934
— 742 — 742
Franchise agreements, net
5,657 — — 5,657
Intercompany receivable (payable)
171,485 (171,972 ) 487 —
Investment in subsidiaries
43,786 — (43,786 ) —
3,617 8,358 (1,639 ) 10,336
$ 385,862 $ 189,899 $ (102,180 ) $ 473,581
Current portion of long-term debt
$ 6,075 $ 42 $ — $ 6,117
8,708 7,587 — 16,295
892 2,715 — 3,607
Long-term debt, net of current portion
301,694 1,018 — 302,712
7,581 110,462 (70,728 ) 47,315
18,380 5,500 7,851 31,731
Accrued postretirement benefits
13,433 7,406 570 21,409
386,979 150,026 (62,307 ) 474,698
(1,117 ) 39,873 (39,873 ) (1,117 )
$ 380,572 $ 180,652 $ (95,666 ) $ 465,558
10,436 9,618 — 20,054
933 — — 933
297,117 1,037 298,154
13,065 108,089 (68,465 ) 52,689
CONSOLIDATING STATEMENT OF OPERATIONS
Three Months Ended June 30, 2008
$ 101,842 $ 108,489 $ — $ 210,331
101,842 108,840 — 210,682
Restaurant wages and related expenses (including stock-based compensation expense of $57)
General and administrative (including stock based compensation expense of $435)
3,843 4,559 (325 ) 8,077
71 10 — 81
— (119 ) — (119 )
97,183 100,362 1,056 198,601
6,061 2,596 (1,534 ) 7,123
Gain on extinguishment of debt
(180 ) — — (180 )
Intercompany interest allocations
(4,557 ) 4,557 — —
1,165 436 279 1,880
Equity income from subsidiaries
1,088 — (1,088 ) —
$ 3,258 $ 889 $ (889 ) $ 3,258
$ 96,928 $ 103,189 $ — $ 200,117
96,928 103,521 — 200,449
91,633 92,454 1,000 185,087
5,295 11,067 (1,000 ) 15,362
$ 5,099 $ 2,607 $ (2,607 ) $ 5,099
Six Months Ended June 30, 2008
53,543 68,029 — 121,572
Restaurant wages and related expenses (including stock-based compensation expense of $114)
7,727 9,014 (642 ) 16,099
Impairment loss
92 10 — 102
186,129 196,436 2,094 384,659
12,434 5,163 (3,040 ) 14,557
General and administrative (including stock-based compensation expense of $633)
1,643 7,685 904 10,232
507 2,760 287 3,554
CONSOLIDATING STATEMENT OF CASH FLOWS
Cash flows provided from (used for) operating activities:
Adjustments to reconcile net income to net cash provided from (used for) operating activities:
51 (63 ) — (12 )
779 187 — 966
567 105 (77 ) 595
(1,077 ) — — (1,077 )
(653 ) (133 ) (258 ) (1,044 )
Loss on settlements of lease financing obligations
31 — — 31
10 110 — 120
259 (402 ) 392 249
(180 ) — (180 )
(13,828 ) 9,274 2,348 (2,206 )
(485 ) 19,865 — 19,380
(1,067 ) (15,318 ) — (16,385 )
(3,532 ) (2,636 ) — (6,168 )
(895 ) (1,690 ) — (2,585 )
2,557 — 2,100 4,657
(4,534 ) (22,019 ) 2,100 (24,453 )
Cash flows provided from financing activities:
(52,900 ) — — (52,900 )
(45 ) (26 ) — (71 )
— (88 ) 88 —
Proceeds from lease financing obligations
— 2,188 (2,188 ) —
Net cash provided from financing activities
(2,884 ) (80 ) — (2,964 )
133 (24 ) — 109
(593 ) (127 ) (249 ) (969 )
Gain on settlements of lease financing obligations
(210 ) (323 ) 323 (210 )
(5,561 ) 6,502 5,538 6,479
9,820 19,767 — 29,587
(911 ) (17,809 ) — (18,720 )
(1,386 ) (107 ) — (1,493 ) | {"pred_label": "__label__cc", "pred_label_prob": 0.6421958804130554, "wiki_prob": 0.3578041195869446, "source": "cc/2023-06/en_head_0021.json.gz/line157485"} |
professional_accounting | 595,852 | 496.080815 | 14 | For the transition period from to
ITRON, INC.
(State of Incorporation)
2111 N Molter Road, Liberty Lake, Washington 99019
(Address and telephone number of registrant's principal executive offices)
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Accelerated filer
Non-accelerated filer
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Trading Symbol(s)
Name of each exchange on which registered
Common stock, no par value
As of April 30, 2019, there were outstanding 39,349,003 shares of the registrant's common stock, no par value, which is the only class of common stock of the registrant.
PART I: FINANCIAL INFORMATION
Item 1: Financial Statements (Unaudited)
Consolidated Statements of Comprehensive Income (Loss)
Consolidated Statements of Equity
Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3: Quantitative and Qualitative Disclosures About Market Risk
Item 4: Controls and Procedures
PART II: OTHER INFORMATION
Item 1: Legal Proceedings
Item 1A: Risk Factors
Item 2: Unregistered Sales of Equity Securities and Use of Proceeds
Item 5: Other Information
Item 6: Exhibits
In thousands, except per share data
Product revenues
Service revenues
Product cost of revenues
Service cost of revenues
Sales, general and administrative
Total other income (expense)
Income tax benefit (provision)
Net loss attributable to Itron, Inc.
Net income (loss) per common share - Basic
Net income (loss) per common share - Diluted
The accompanying notes are an integral part of these condensed consolidated financial statements.
In thousands
Foreign currency translation adjustments
Net unrealized gain (loss) on derivative instruments, designated as cash flow hedges
Pension benefit obligation adjustment
Total comprehensive income (loss), net of tax
Comprehensive income attributable to noncontrolling interests, net of tax
Comprehensive income (loss) attributable to Itron, Inc.
Property, plant, and equipment, net
Operating lease right-of-use assets, net
Wages and benefits payable
Taxes payable
Current portion of debt
Current portion of warranty
Long-term warranty
Pension benefit obligation
Deferred tax liabilities, net
Other long-term obligations
Commitments and contingencies (Note 11)
Preferred stock, no par value, 10,000 shares authorized, no shares issued or outstanding
Common stock, no par value, 75,000 shares authorized, 39,693 and 39,498 shares issued and outstanding
Accumulated other comprehensive loss, net
Total Itron, Inc. shareholders' equity
Balances at January 1, 2019
Other comprehensive income (loss), net of tax
Distributions to noncontrolling interests
Stock issues and repurchases:
Options exercised
Restricted stock awards released net of repurchased shares for taxes
Issuance of stock-based compensation awards
Shares repurchased
Balances at March 31, 2019
Cumulative effect of accounting change
Restricted stock awards released
SSNI acquisition adjustments, net
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization of intangible assets
Amortization of operating lease right-of-use assets
Amortization of prepaid debt fees
Restructuring, non-cash
Other adjustments, net
Changes in operating assets and liabilities, net of acquisitions:
Accounts payable, other current liabilities, and taxes payable
Other operating, net
Acquisitions of property, plant, and equipment
Business acquisitions, net of cash equivalents acquired
Other investing, net
Proceeds from borrowings
Payments on debt
Prepaid debt fees
Other financing, net
Effect of foreign exchange rate changes on cash, cash equivalents, and restricted cash
Decrease in cash, cash equivalents, and restricted cash
Income taxes, net
In this Quarterly Report on Form 10-Q, the terms "we," "us," "our," "Itron," and the "Company" refer to Itron, Inc.
The condensed consolidated financial statements presented in this Quarterly Report on Form 10-Q are unaudited and reflect entries necessary for the fair presentation of the Consolidated Statements of Operations, the Consolidated Statements of Comprehensive Income (Loss), Consolidated Statements of Equity, and Consolidated Statements of Cash Flows for the three months ended March 31, 2019 and 2018, and the Consolidated Balance Sheets as of March 31, 2019 and December 31, 2018, of Itron, Inc. and its subsidiaries. All entries required for the fair presentation of the financial statements are of a normal recurring nature, except as disclosed. The results of operations for the three months ended March 31, 2019 are not necessarily indicative of the results expected for the full year or for any other period.
Certain information and notes normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (GAAP) have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) regarding interim results. These condensed consolidated financial statements should be read in conjunction with the audited financial statements and notes included in our 2018 Annual Report on Form 10-K filed with the SEC on February 28, 2019. There have been no significant changes in financial statement preparation or significant accounting policies since December 31, 2018 other than the adoption of Accounting Standards Codification (ASC) 842, Leases.
Restricted Cash and Cash Equivalents
Cash and cash equivalents that are contractually restricted from operating use are classified as restricted cash and cash equivalents.
The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported within the Consolidated Balance Sheets that sum to the total of the same such amounts shown in the Consolidated Statements of Cash Flows:
Current restricted cash included in other current assets
Long-term restricted cash
Total cash, cash equivalents, and restricted cash
Subsequent to the issuance of our March 31, 2018 consolidated financial statements, we determined $150 million of proceeds from borrowings and payments on debt, originally transacted during the first quarter of 2018, had been improperly netted within the financing activities section of the Consolidated Statements of Cash Flows for the first three quarters of 2018. We corrected this presentation for the 2018 Annual Report on Form 10‑K. The accompanying Consolidated Statement of Cash Flows for the three months ended March 31, 2018 has been revised from amounts previously reported to separately present the $150 million of proceeds from borrowings and the payments on debt. We assessed the significance of the misstatement and concluded that it was not material to any prior periods. There were no changes to net cash flows from operating, investing, or financing activities as a result of this change.
We determine if an arrangement is a lease at inception. A lease exists when a contract conveys to the customer the right to control the use of identified property, plant, or equipment for a period of time in exchange for consideration. The definition of a lease embodies two conditions: (1) there is an identified asset in the contract that is land or a depreciable asset (i.e., property, plant, and equipment), and (2) the customer has the right to control the use of the identified asset.
Operating leases are included in operating lease right-of-use ("ROU") assets, other current liabilities, and operating lease liabilities on our Consolidated Balance Sheets. Finance leases are included in property, plant, and equipment, other current liabilities, and other long-term liabilities on our Consolidated Balance Sheets.
ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. We use the implicit rate when readily determinable. As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. The Operating ROU asset also includes any lease payments made and excludes lease incentives received and initial direct costs incurred. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Lease expense for operating lease payments is recognized on a straight-line basis over the lease term.
We have lease agreements, which include lease and nonlease components. For each of our existing asset classes, we have elected the practical expedient to account for the lease and nonlease components as a single lease component when the nonlease components are fixed.
We have not elected to utilize the short-term lease exemption for any leased asset class. All leases with a lease term that is greater than one month will be subject to recognition and measurement on the balance sheet.
Lease expense for variable lease payments, where the timing or amount of the payment is not fixed, are recognized when the obligation is incurred. Variable lease payments generally arise in our net lease arrangements where executory and other lease-related costs are billed to Itron when incurred by the lessor.
Recently Adopted Accounting Standards
In February 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-02, Leases (Topic 842) (ASU 2016-02), which required substantially all leases be recognized by lessees on their balance sheet as a right-of-use asset and corresponding lease liability, including leases previously accounted for as operating leases. The new standard also resulted in enhanced quantitative and qualitative disclosures, including significant judgments made by management, to provide greater insight into the extent of revenue and expense recognized and expected to be recognized from existing leases. The standard required modified retrospective adoption and was effective for annual reporting periods beginning after December 15, 2018, with early adoption permitted. In July 2018, the FASB issued ASU 2018-10, Codification Improvements to Topic 842, Leases (ASU 2018-10), to clarify, improve, and correct various aspects of ASU 2016-02, and also issued ASU 2018-11, Targeted Improvements to Topic 842, Leases (ASU 2018-11), to simplify transition requirements and, for lessors, provide a practical expedient for the separation of nonlease components from lease components. In March 2019, the FASB issued a second Codification Improvements to Topic 842, Leases (ASU 2019-01) to provide further guidance and clarity on several topics of ASU 2016-02. The effective date and transition requirements in ASU 2018-10, ASU 2018-11, and ASU 2019-01 are the same as the effective date and transition requirements of ASU 2016-02. We adopted Accounting Standards Codification (ASC) 842 on January 1, 2019 and it resulted in an increase to operating lease right-of-use assets, other current liabilities, and operating lease liabilities of $74.6 million, $14.5 million, and $61.5 million, respectively, and a decrease in other current assets and other long-term obligations of $1.5 million and $2.9 million, respectively.
In October 2018, the FASB issued ASU 2018-16, Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes. We adopted this standard on January 1, 2019, and it did not materially impact our consolidated financial statements. This update establishes OIS rates based on SOFR as an approved benchmark interest rate in addition to existing rates such as the LIBOR swap rate.
Recent Accounting Standards Not Yet Adopted
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326) (ASU 2016-13), which replaces the incurred loss impairment methodology in current GAAP with a methodology based on expected credit losses. This estimate of expected credit losses uses a broader range of reasonable and supportable information. This change will result in earlier recognition of credit losses. ASU 2016-13 is effective for annual reporting periods, and interim periods within those years, beginning after December 15, 2019. We are currently evaluating the impact of this standard on our consolidated financial statements, including accounting policies, processes, and systems.
In August 2018, the FASB issued ASU 2018-13, Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement (ASU 2018-13), which amends the disclosure requirements under ASC 820, Fair Value Measurements. ASU 2018-13 is effective for us beginning with our interim financial reports for the first quarter of 2020. We are currently evaluating the impact this standard will have on our consolidated financial statement disclosures related to assets and liabilities subject to fair value measurement.
In August 2018, the FASB issued ASU 2018-14, Disclosure Framework-Changes to the Disclosure Requirements for Defined Benefit Plans (ASU 2018-14), which amends the disclosure requirements under ASC 715-20, Compensation-Retirement Benefits-Defined Benefit Plans. ASU 2018-14 is effective for our financial reporting in 2020. We are currently evaluating the impact this standard will have on our financial statement disclosures for our defined benefit plan.
Note 2: Earnings Per Share
The following table sets forth the computation of basic and diluted earnings (loss) per share (EPS):
Net loss available to common shareholders
Dilutive effect of stock-based awards
Net loss per common share - Basic
Net loss per common share - Diluted
Stock-based Awards
For stock-based awards, the dilutive effect is calculated using the treasury stock method. Under this method, the dilutive effect is computed as if the awards were exercised at the beginning of the period (or at time of issuance, if later) and assumes the related proceeds were used to repurchase common stock at the average market price during the period. Related proceeds include the amount the employee must pay upon exercise and the future compensation cost associated with the stock award. Approximately 1.0 million and 1.0 million stock-based awards were excluded from the calculation of diluted EPS for the three months ended March 31, 2019 and 2018 because they were anti-dilutive. These stock-based awards could be dilutive in future periods.
Note 3: Certain Balance Sheet Components
A summary of accounts receivable from contracts with customers is as follows:
Trade receivables (net of allowance of $4,046 and $6,331)
Unbilled receivables
Total accounts receivable, net
Allowance for doubtful accounts activity
Beginning balance
Accounts written-off
Effect of change in exchange rates
Buildings, furniture, and improvements
Construction in progress, including purchased equipment
Depreciation expense
Subsequent to March 31, 2019, we entered into sales contracts for properties in Massy, France and Stretford, United Kingdom, which properties are classified as held-for-sale within other long-term assets. The estimated gains on sale are $1.5 million and $5.0 million, respectively. The Massy, France gain will be classified within operating expenses as a gain on sale of assets, and the Stretford, United Kingdom gain will offset restructuring expense as this property was included in a previous restructuring plan.
Note 4: Intangible Assets and Liabilities
The gross carrying amount and accumulated amortization (accretion) of our intangible assets and liabilities, other than goodwill, were as follows:
(Amortization) Accretion
Core-developed technology
Customer contracts and relationships
Trademarks and trade names
Total intangible assets subject to amortization
Total intangible assets
Intangible Liabilities
A summary of intangible assets and liabilities activity is as follows:
Beginning balance, intangible assets, gross
Intangible assets acquired
Ending balance, intangible assets, gross
Beginning balance, intangible liabilities, gross
Intangible liabilities acquired
Ending balance, intangible liabilities, gross
On January 5, 2018, we completed our acquisition of Silver Spring Networks, Inc. (SSNI) by purchasing 100% of the voting stock. Acquired intangible assets include in-process research and development (IPR&D), which is not amortized until such time as the associated development projects are completed. Of these projects, $0.2 million were completed during the three months ended March 31, 2019 and are included in core-developed technology. The remaining IPR&D is expected to be completed in 2019. Acquired intangible liabilities reflect the present value of the projected cash outflows for an existing contract where remaining costs are expected to exceed projected revenues.
Estimated future annual amortization (accretion) is as follows:
Year Ending December 31,
Estimated Annual Amortization, net
2019 (amount remaining at March 31, 2019)
Total intangible assets subject to amortization (accretion)
We have recognized $16.0 million and $17.7 million of net amortization of intangible assets for the three months ended March 31, 2019 and 2018, respectively, within operating expenses in the Consolidated Statement of Operations. These expenses relate to intangible assets and liabilities acquired as part of business combinations.
Note 5: Goodwill
The following table reflects goodwill allocated to each reporting unit:
Device Solutions
Goodwill balance at January 1, 2019
Measurement period adjustments to goodwill acquired
Goodwill balance at March 31, 2019
Silver Spring Networks, Inc. Acquisition
On January 5, 2018, we completed the acquisition of SSNI by purchasing 100% of SSNI's outstanding stock. The acquisition was financed through incremental borrowings and cash on hand. Refer to "Note 6: Debt" for further discussion of our debt. SSNI provided smart network and data platform solutions for electricity, gas, water and smart cities including advanced metering, distribution automation, demand-side management, and street lights.
The fair values for the identified trademarks and core-developed technology intangible assets were estimated using the relief from royalty method. The fair value of customer contract and relationship were estimated using the income approach. The IPR&D was valued utilizing the replacement cost method. These consolidated financial statements should be read in conjunction with the audited financial statements and notes included in our 2018 Annual Report on Form 10-K filed with the SEC on February 28, 2019.
The purchase price of SSNI was $809.2 million, which is net of $97.8 million of acquired cash and cash equivalents. Of the total consideration, $802.5 million was paid in cash. The remaining $6.7 million relates to the fair value of pre-acquisition service for replacement awards of unvested SSNI options and restricted stock unit awards with an Itron equivalent award. We allocated the purchase price to the assets acquired and liabilities assumed based on estimated fair value assessments. During the three months ended March 31, 2019, we recognized additional contract assets totaling $8.0 million and additional deferred tax liabilities of $2.0 million, for a net reduction in goodwill of $6.0 million. As of the first quarter of 2019, the measurement period for the acquisition of SSNI is complete, and any further adjustments to assets acquired or liabilities assumed will be recognized through the Consolidated Statement of Operations.
Note 6: Debt
The components of our borrowings were as follows:
Credit facility:
USD denominated term loan
Multicurrency revolving line of credit
Less: current portion of debt
Less: unamortized prepaid debt fees - term loan
Less: unamortized prepaid debt fees - senior notes
On January 5, 2018, we entered into a credit agreement providing for committed credit facilities in the amount of $1.2 billion U.S. dollars (the 2018 credit facility), which amended and restated in its entirety our credit agreement dated June 23, 2015 and replaced committed facilities in the amount of $725 million. The 2018 credit facility consists of a $650 million U.S. dollar term loan (the term loan) and a multicurrency revolving line of credit (the revolver) with a principal amount of up to $500 million. The revolver also contains a $300 million standby letter of credit sub-facility and a $50 million swingline sub-facility. Both the term loan and the revolver mature on January 5, 2023 and can be repaid without penalty. Amounts repaid on the term loan may not be reborrowed and amounts borrowed under the revolver may be repaid and reborrowed until the revolver's maturity, at which time all outstanding loans together with all accrued and unpaid interest must be repaid. Amounts not borrowed under the revolver are subject to a commitment fee, which is paid in arrears on the last day of each fiscal quarter, ranging from 0.18% to 0.35% per annum depending on our total leverage ratio as of the most recently ended fiscal quarter.
The 2018 credit facility permits us and certain of our foreign subsidiaries to borrow in U.S. dollars, euros, British pounds, or, with lender approval, other currencies readily convertible into U.S. dollars. All obligations under the 2018 credit facility are guaranteed by Itron, Inc. and material U.S. domestic subsidiaries and are secured by a pledge of substantially all of the assets of Itron, Inc. and material U.S. domestic subsidiaries, including a pledge of their related assets. This includes a pledge of 100% of the capital stock of material U.S. domestic subsidiaries and up to 66% of the voting stock (100% of the non-voting stock) of first-tier foreign subsidiaries. In addition, the obligations of any foreign subsidiary who is a foreign borrower, as defined by the 2018 credit facility, are guaranteed by the foreign subsidiary and by its direct and indirect foreign parents. The 2018 credit facility includes debt covenants, which contain certain financial thresholds and place certain restrictions on the incurrence of debt, investments, and the issuance of dividends. We were in compliance with the debt covenants under the 2018 credit facility at March 31, 2019.
Under the 2018 credit facility, we elect applicable market interest rates for both the term loan and any outstanding revolving loans. We also pay an applicable margin, which is based on our total leverage ratio as defined in the credit agreement. The applicable rates per annum may be based on either: (1) the LIBOR rate or EURIBOR rate (subject to a floor of 0%), plus an applicable margin, or (2) the Alternate Base Rate, plus an applicable margin. The Alternate Base Rate election is equal to the greatest of three rates: (i) the prime rate, (ii) the Federal Reserve effective rate plus 0.50%, or (iii) one-month LIBOR plus 1.00%. At March 31, 2019, the interest rate for both the term loan and revolver was 4.50%, which includes the LIBOR rate plus a margin of 2.00%.
On December 22, 2017 and January 19, 2018, we issued $300 million and $100 million, respectively, of aggregate principal amount of 5.00% senior notes maturing January 15, 2026 (Notes). The proceeds were used to refinance existing indebtedness related to the acquisition of SSNI, pay related fees and expenses, and for general corporate purposes. Interest on the Notes is payable semi-annually in arrears on January 15 and July 15, commencing on July 15, 2018. The Notes are fully and unconditionally guaranteed, jointly and severally, on a senior unsecured basis by each of our subsidiaries that guarantee the senior credit facilities.
Prior to maturity we may redeem some or all of the Notes, together with accrued and unpaid interest, if any, plus a "make-whole" premium. On or after January 15, 2021, we may redeem some or all of the Notes at any time at declining redemption prices equal to 102.50% beginning on January 15, 2021, 101.25% beginning on January 15, 2022 and 100.00% beginning on January15, 2023 and thereafter to the applicable redemption date. In addition, before January 15, 2021, and subject to certain conditions, we may redeem up to 35% of the aggregate principal amount of Notes with the net proceeds of certain equity offerings at 105.00% of the principal amount thereof to the date of redemption; provided that (i) at least 65% of the aggregate principal amount of Notes remains outstanding after such redemption and (ii) the redemption occurs within 60 days of the closing of any such equity offering.
Debt Maturities
The amount of required minimum principal payments on our long-term debt in aggregate over the next five years, are as follows:
Minimum Payments
Total minimum payments on debt
Note 7: Derivative Financial Instruments
As part of our risk management strategy, we use derivative instruments to hedge certain foreign currency and interest rate exposures. Refer to "Note 13: Shareholder's Equity" and "Note 14: Fair Values of Financial Instruments" for additional disclosures on our derivative instruments.
The fair values of our derivative instruments are determined using the income approach and significant other observable inputs (also known as "Level 2"). We have used observable market inputs based on the type of derivative and the nature of the underlying instrument. The key inputs include interest rate yield curves (swap rates and futures) and foreign exchange spot and forward rates, all of which are available in an active market. We have utilized the mid-market pricing convention for these inputs. We include, as a discount to the derivative asset, the effect of our counterparty credit risk based on current published credit default swap rates when the net fair value of our derivative instruments is in a net asset position. We consider our own nonperformance risk when the net fair value of our derivative instruments is in a net liability position by discounting our derivative liabilities to reflect the potential credit risk to our counterparty through applying a current market indicative credit spread to all cash flows.
The fair values of our derivative instruments were as follows:
Balance Sheet Location
Derivatives designated as hedging instruments under Subtopic 815-20
Interest rate swap contract
Interest rate cap contracts
Cross currency swap contract
Derivatives not designated as hedging instruments under Subtopic 815-20
Foreign exchange forward contracts
Total asset derivatives
The changes in accumulated other comprehensive income (loss) (AOCI), net of tax, for our derivative and nonderivative hedging instruments designated as hedging instruments, net of tax, were as follows:
Net unrealized loss on hedging instruments at January 1,
Unrealized gain (loss) on hedging instruments
Realized (gains) losses reclassified into net income (loss)
Net unrealized loss on hedging instruments at March 31,
Reclassification of amounts related to hedging instruments are included in interest expense in the Consolidated Statements of Operations for the periods ended March 31, 2019 and 2018. Included in the net unrealized gain (loss) on hedging instruments at March 31, 2019 and 2018 is a loss of $14.4 million, net of tax, related to our nonderivative net investment hedge, which terminated in 2011. This loss on our net investment hedge will remain in AOCI until such time when earnings are impacted by a sale or liquidation of the associated foreign operation.
A summary of the effect of netting arrangements on our financial position related to the offsetting of our recognized derivative assets and liabilities under master netting arrangements or similar agreements is as follows:
Offsetting of Derivative Assets
Gross Amounts of Recognized Assets Presented in
the Consolidated
Gross Amounts Not Offset in the Consolidated Balance Sheets
Derivative Financial Instruments
Cash Collateral Received
Offsetting of Derivative Liabilities
Gross Amounts of Recognized Liabilities Presented in the Consolidated Balance Sheets
Cash Collateral Pledged
Our derivative assets and liabilities subject to netting arrangements consist of foreign exchange forwards and options and interest rate contracts with six counterparties at March 31, 2019 and five counterparties at December 31, 2018. No derivative asset or liability balance with any of our counterparties was individually significant at March 31, 2019 or December 31, 2018. Our derivative contracts with each of these counterparties exist under agreements that provide for the net settlement of all contracts through a single payment in a single currency in the event of default. We have no pledges of cash collateral against our obligations nor have we received pledges of cash collateral from our counterparties under the associated derivative contracts.
Cash Flow Hedges
As a result of our floating rate debt, we are exposed to variability in our cash flows from changes in the applicable interest rate index. We enter into interest rate caps and swaps to reduce the variability of cash flows from increases in the LIBOR based borrowing rates on our floating rate credit facility. These instruments do not protect us from changes to the applicable margin under our credit facility. At March 31, 2019, our LIBOR-based debt balance was $623.8 million.
In October 2015, we entered into an interest rate swap, which is effective from August 31, 2016 to June 23, 2020, and converts $214 million of our LIBOR based debt from a floating LIBOR interest rate to a fixed interest rate of 1.42% (excluding the applicable margin on the debt). The notional balance will amortize to maturity at the same rate as required minimum payments on our term loan. Changes in the fair value of the interest rate swap are recognized as a component of other comprehensive income (OCI) and are recognized in earnings when the hedged item affects earnings. The amounts paid or received on the hedge are recognized as an adjustment to interest expense along with the earnings effect of the hedged item. The amount of net gains expected to be reclassified into earnings in the next 12 months is $1.6 million.
In November 2015, we entered into three interest rate cap contracts with a total notional amount of $100 million at a cost of $1.7 million. The interest rate cap contracts expire on June 23, 2020 and were entered into in order to limit our interest rate exposure on $100 million of our variable LIBOR based debt up to 2.00%. In the event LIBOR is higher than 2.00%, we will pay interest at the capped rate of 2.00% with respect to the $100 million notional amount of such agreements. As of December 31, 2016, due to the accelerated revolver payments from surplus cash, we elected to de-designate two of the interest rate cap contracts as cash flow hedges and discontinued the use of cash flow hedge accounting. The amounts recognized in AOCI from de-designated interest rate cap contracts were maintained in AOCI as the forecasted transactions were still probable to occur, and subsequent changes in fair value were recognized within interest expense. In April 2018, due to increases in our total LIBOR-based debt, we elected to re-designate the two interest rate cap contracts as cash flow hedges. Future changes in the fair value of these instruments will be recognized as a component of OCI, and these changes together with amounts previously maintained in AOCI will be recognized in earnings when the hedged item affects earnings. The amounts paid or received on the hedge are recognized as an adjustment to interest expense along with the earnings effect of the hedged item. The amount of net losses expected to be reclassified into earnings for all interest rate cap contracts in the next 12 months is $0.3 million.
In April 2018, we entered into a cross-currency swap, which converts $56.0 million of floating LIBOR-based U.S. Dollar denominated debt into 1.38% fixed rate euro denominated debt. This cross-currency swap matures on April 30, 2021 and mitigates the risk associated with fluctuations in currency rates impacting cash flows related to U.S. Dollar denominated debt in a euro functional currency entity. Changes in the fair value of the cross-currency swap are recognized as a component of OCI and will be recognized in earnings when the hedged item affects earnings. The amounts paid or received on the hedge are recognized as an adjustment to interest expense along with the earnings effect of the hedged item. The amount of net gains expected to be reclassified into earnings in the next 12 months is $1.6 million.
As a result of our forecasted purchases in non-functional currency, we are exposed to foreign exchange risk. We hedge portions of our forecasted foreign currency inventory purchases. During January 2019, we entered into foreign exchange option contracts for a total notional amount of $72 million at a cost of $1.3 million. The contracts will mature ratably through the year with final maturity in October 2019. Changes in the fair value of the option contracts are recognized as a component of OCI and will be recognized in product cost of revenues when the hedged item affects earnings.
The before-tax effects of our accounting for derivative instruments designated as hedges on AOCI were as follows:
Derivatives in Subtopic 815-20
Hedging Relationships
Amount of Gain (Loss)
Recognized in OCI on
Gain (Loss) Reclassified from
AOCI into Income
Interest rate swap contracts
Other income/(expense), net
These reclassification amounts presented above also represent the loss (gain) recognized in net income (loss) on hedging relationships under Subtopic 815-20 on the Consolidated Statements of Operations. For the three months ended March 31, 2019 and 2018, there were no amounts reclassified from AOCI as a result that a forecasted transaction is no longer probable of occurring, and no amounts excluded from effectiveness testing recognized in earnings based on changes in fair value.
Derivatives Not Designated as Hedging Relationships
We are also exposed to foreign exchange risk when we enter into non-functional currency transactions, both intercompany and third party. At each period-end, non-functional currency monetary assets and liabilities are revalued with the change recognized to other income and expense. We enter into monthly foreign exchange forward contracts, which are not designated for hedge accounting, with the intent to reduce earnings volatility associated with currency exposures. As of March 31, 2019, a total of 51 contracts were offsetting our exposures from the Euro, Pound Sterling, Indonesian Rupiah, Chinese Yuan, Canadian Dollar, Indian Rupee and various other currencies, with notional amounts ranging from $109,000 to $7.6 million.
The effect of our derivative instruments not designated as hedges on the Consolidated Statements of Operations was as follows:
Derivatives Not Designated as Hedging Instrument under Subtopic 815-20
Gain (Loss) Recognized on Derivatives in Other Income (Expense)
Note 8: Defined Benefit Pension Plans
We sponsor both funded and unfunded defined benefit pension plans offering death and disability, retirement, and special termination benefits for our international employees, primarily in Germany, France, Italy, Indonesia, Brazil, and Spain. The defined benefit obligation is calculated annually by using the projected unit credit method. The measurement date for the pension plans was December 31, 2018.
Amounts recognized on the Consolidated Balance Sheets consist of:
Plan assets in other long-term assets
Current portion of pension benefit obligation in wages and benefits payable
Long-term portion of pension benefit obligation
Pension benefit obligation, net
Our asset investment strategy focuses on maintaining a portfolio using primarily insurance funds, which are accounted for as investments and measured at fair value, in order to achieve our long-term investment objectives on a risk adjusted basis. Our
general funding policy for these qualified pension plans is to contribute amounts sufficient to satisfy regulatory funding standards of the respective countries for each plan.
Net periodic pension benefit costs for our plans include the following components:
Interest cost
Expected return on plan assets
Amortization of actuarial net loss
Amortization of unrecognized prior service costs
Net periodic benefit cost
The components of net periodic benefit cost, other than the service cost component, are included in total other income (expense) on the Consolidated Statements of Operations.
Note 9: Stock-Based Compensation
We maintain the Second Amended and Restated 2010 Stock Incentive Plan (Stock Incentive Plan), which allows us to grant stock-based compensation awards, including stock options, restricted stock units, phantom stock, and unrestricted stock units. Under the Stock Incentive Plan, we have 12,623,538 shares of common stock reserved and authorized for issuance subject to stock splits, dividends, and other similar events. At March 31, 2019, 6,318,953 shares were available for grant under the Stock Incentive Plan. We issue new shares of common stock upon the exercise of stock options or when vesting conditions on restricted stock units are fully satisfied. These shares are subject to a fungible share provision such that the authorized share reserve is reduced by (i) one share for every one share subject to a stock option or share appreciation right granted under the Plan and (ii) 1.7 shares for every one share of common stock that was subject to an award other than an option or share appreciation right.
As part of the acquisition of SSNI, we reserved and authorized 2,880,039 shares, collectively, of Itron common stock to be issued under the Stock Incentive Plan for certain SSNI common stock awards that were converted to Itron common stock awards on January 5, 2018 (Acquisition Date) pursuant to the Agreement and Plan of Merger or were available for issuance pursuant to future awards under the Silver Spring Networks, Inc. 2012 Equity Incentive Plan (SSNI Plan). New stock-based compensation awards originally from the SSNI Plan may only be made to individuals who were not employees of Itron as of the Acquisition Date. Notwithstanding the foregoing, there is no fungible share provision for shares originally from the SSNI Plan.
We also periodically award phantom stock units, which are settled in cash upon vesting and accounted for as liability-based awards with no impact to the shares available for grant.
In addition, we maintain the Employee Stock Purchase Plan (ESPP), for which 272,602 shares of common stock were available for future issuance at March 31, 2019.
Unrestricted stock and ESPP activity for the three months ended March 31, 2019 and 2018 was not significant.
Total stock-based compensation expense and the related tax benefit were as follows:
Restricted stock units
Unrestricted stock awards
Phantom stock units
Total stock-based compensation
Related tax benefit
A summary of our stock option activity is as follows:
Average Exercise
Price per Share
Contractual Life
Average Grant
Date Fair Value
Outstanding, January 1, 2018
Converted upon acquisition
Exercised
Outstanding, March 31, 2018
Exercisable, March 31, 2019
Expected to vest, March 31, 2019
At March 31, 2019, total unrecognized stock-based compensation expense related to nonvested stock options was $1.8 million, which is expected to be recognized over a weighted average period of approximately 1.6 years.
The weighted-average assumptions used to estimate the fair value of stock options granted and the resulting weighted average fair value are as follows:
Expected volatility
Risk-free interest rate
Expected term (years)
There were no employee stock options granted for the three months ended March 31, 2019.
The following table summarizes restricted stock unit activity:
Vested but not released, March 31, 2019
(1) Shares released is presented gross of shares netted for employee payroll tax obligations.
At March 31, 2019, total unrecognized compensation expense on restricted stock units was $36.2 million, which is expected to be recognized over a weighted average period of approximately 2.0 years.
The weighted-average assumptions used to estimate the fair value of performance-based restricted stock units granted and the resulting weighted average fair value are as follows:
Weighted average fair value
The following table summarizes phantom stock unit activity:
Number of Phantom Stock Units
At March 31, 2019, total unrecognized compensation expense on phantom stock units was $2.5 million, which is expected to be recognized over a weighted average period of approximately 2.1 years. As of both March 31, 2019 and December 31, 2018, we have recognized a phantom stock liability of $0.3 million and $1.5 million, respectively, within wages and benefits payable in the Consolidated Balance Sheets.
Note 10: Income Taxes
We determine the interim tax benefit (provision) by applying an estimate of the annual effective tax rate to the year-to-date pretax book income (loss) and adjusting for discrete items during the reporting period, if any. Tax jurisdictions with losses for which tax benefits cannot be realized are excluded.
Our tax rate for the three months ended March 31, 2019 of 102% differed from the federal statutory rate of 21% due primarily to unbenefitted losses experienced in jurisdictions with valuation allowances on deferred tax assets as well as the forecasted mix of earnings in domestic and international jurisdictions.
Our tax rate for the three months ended March 31, 2018 of 7% differed from the federal statutory rate of 21% due primarily to unbenefitted losses experienced in jurisdictions with valuation allowances on deferred tax assets as well as the forecasted mix of earnings in domestic and international jurisdictions, a benefit related to excess stock-based compensation, and uncertain tax positions.
We classify interest expense and penalties related to unrecognized tax liabilities and interest income on tax overpayments as components of income tax expense. The net interest and penalties expense recognized were as follows:
Net interest and penalties expense
Accrued interest and penalties recognized were as follows:
Accrued penalties
Unrecognized tax benefits related to uncertain tax positions and the amount of unrecognized tax benefits that, if recognized, would affect our effective tax rate were as follows:
Unrecognized tax benefits related to uncertain tax positions
The amount of unrecognized tax benefits that, if recognized, would affect our effective tax rate
At March 31, 2019, we are under examination by certain tax authorities for the 2010 to 2017 tax years. The material jurisdictions where we are subject to examination for the 2010 to 2017 tax years include, among others, the United States, France, Germany, Italy, Brazil and the United Kingdom. No material changes have occurred to previously disclosed assessments. We believe we have appropriately accrued for the expected outcome of all tax matters and do not currently anticipate that the ultimate resolution of these examinations will have a material adverse effect on our financial condition, future results of operations, or liquidity.
Based upon the timing and outcome of examinations, litigation, the impact of legislative, regulatory, and judicial developments, and the impact of these items on the statute of limitations, it is reasonably possible that the related unrecognized tax benefits could change from those recognized within the next twelve months. However, at this time, an estimate of the range of reasonably possible adjustments to the balance of unrecognized tax benefits cannot be made.
Note 11: Commitments and Contingencies
Guarantees and Indemnifications
We are often required to obtain standby letters of credit (LOCs) or bonds in support of our obligations for customer contracts. These standby LOCs or bonds typically provide a guarantee to the customer for future performance, which usually covers the installation phase of a contract and may, on occasion, cover the operations and maintenance phase of outsourcing contracts.
Our available lines of credit, outstanding standby LOCs, and performance bonds were as follows:
Standby LOCs issued and outstanding
Net available for additional borrowings under the multi-currency revolving line of credit
Net available for additional standby LOCs under sub-facility
Unsecured multicurrency revolving lines of credit with various financial institutions
Multicurrency revolving lines of credit
Short-term borrowings
Net available for additional borrowings and LOCs
Unsecured surety bonds in force
In the event any such standby LOC or bond is called, we would be obligated to reimburse the issuer of the standby LOC or bond; however, we do not believe that any outstanding LOC or bond will be called.
We generally provide an indemnification related to the infringement of any patent, copyright, trademark, or other intellectual property right on software or equipment within our sales contracts, which indemnifies the customer from and pays the resulting costs, damages, and attorney's fees awarded against a customer with respect to such a claim provided that (a) the customer promptly notifies us in writing of the claim and (b) we have the sole control of the defense and all related settlement negotiations. We may also provide an indemnification to our customers for third-party claims resulting from damages caused by the negligence or willful misconduct of our employees/agents in connection with the performance of certain contracts. The terms of our indemnifications
generally do not limit the maximum potential payments. It is not possible to predict the maximum potential amount of future payments under these or similar agreements.
We are subject to various legal proceedings and claims of which the outcomes are subject to significant uncertainty. Our policy is to assess the likelihood of any adverse judgments or outcomes related to legal matters, as well as ranges of probable losses. A determination of the amount of the liability required, if any, for these contingencies is made after an analysis of each known issue. A liability is recognized and charged to operating expense when we determine that a loss is probable and the amount can be reasonably estimated. Additionally, we would disclose contingencies for which a material loss is reasonably possible, but not probable.
A summary of the warranty accrual account activity is as follows:
Assumed liabilities from acquisition
New product warranties
Other adjustments and expirations
Claims activity
Less: current portion of warranty
Total warranty expense is classified within cost of revenues and consists of new product warranties issued, costs related to insurance and supplier recoveries, other changes and adjustments to warranties, and customer claims. Warranty expense was as follows:
Total warranty expense
We are self-insured for a substantial portion of the cost of our U.S. employee group health insurance. We purchase insurance from a third party, which provides individual and aggregate stop loss protection for these costs. Each reporting period, we expense the costs of our health insurance plan including paid claims, the change in the estimate of incurred but not reported (IBNR) claims, taxes, and administrative fees (collectively, the plan costs).
Plan costs were as follows:
The IBNR accrual, which is included in wages and benefits payable, was as follows:
IBNR accrual
Our IBNR accrual and expenses may fluctuate due to the number of plan participants, claims activity, and deductible limits. For our employees located outside of the United States, health benefits are provided primarily through governmental social plans, which are funded through employee and employer tax withholdings.
Note 12: Restructuring
On February 22, 2018, our Board of Directors approved a restructuring plan (the 2018 Projects) to continue our efforts to optimize our global supply chain and manufacturing operations, research and development, and sales and marketing organizations. We expect to substantially complete the plan by the end of 2020. Many of the affected employees are represented by unions or works councils, which require consultation, and potential restructuring projects may be subject to regulatory approval, both of which could impact the timing of charges, total expected charges, cost recognized, and planned savings in certain jurisdictions.
The total expected restructuring costs, the restructuring costs recognized, and the remaining expected restructuring costs related to the 2018 Projects are as follows:
Total Expected Costs at March 31, 2019
Costs Recognized in Prior Periods
Costs Recognized During the Three Months Ended
Expected Remaining Costs to be Recognized at
Employee severance costs
Asset impairments & net loss on sale or disposal
Other restructuring costs
On September 1, 2016, we announced projects (2016 Projects) to restructure various company activities in order to improve operational efficiencies, reduce expenses and improve competitiveness. We expect to close or consolidate several facilities and reduce our global workforce as a result of the restructuring. The 2016 Projects were initiated during the third quarter of 2016 and were substantially completed at December 31, 2018.
The following table summarizes the activity within the restructuring related balance sheet accounts for the 2018 and 2016 Projects during the three months ended March 31, 2019:
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professional_accounting | 541,448 | 464.336262 | 14 | Pzena Investment Management, Inc. - FORM 10-Q - August 7, 2017
EX-32.2 - EXHIBIT 32.2 - Pzena Investment Management, Inc. pzn2017q2exhibit322.htm
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the Quarterly Period Ended June 30, 2017
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from ______to______
Commission file number 001-33761
PZENA INVESTMENT MANAGEMENT, INC.
(Former Address of Principal Executive Offices) (Zip Code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. Yes o No o
As of August 4, 2017, there were 17,285,307 outstanding shares of the registrant’s Class A common stock, par value $0.01 per share.
As of August 4, 2017, there were 51,195,179 outstanding shares of the registrant’s Class B common stock, par value $0.000001 per share.
PART I — FINANCIAL INFORMATION
Consolidated Statements of Financial Condition of Pzena Investment Management, Inc.
as of June 30, 2017 (unaudited) and December 31, 2016
Consolidated Statements of Operations (unaudited) of Pzena Investment Management, Inc. for the Three and Six Months Ended June 30, 2017 and 2016
Consolidated Statements of Comprehensive Income (unaudited) of Pzena Investment Management, Inc. for the Three and Six Months Ended June 30, 2017 and 2016
Consolidated Statement of Changes in Equity (unaudited) of Pzena Investment Management, Inc. for the Six Months Ended June 30, 2017 and 2016
Consolidated Statements of Cash Flows (unaudited) of Pzena Investment Management, Inc. for the Three and Six Months Ended June 30, 2017 and 2016
Notes to the Consolidated Financial Statements (unaudited)
PART II — OTHER INFORMATION
This Quarterly Report on Form 10-Q contains forward-looking statements. Forward-looking statements provide our current expectations, or forecasts, of future events. Forward-looking statements include statements about our expectations, beliefs, plans, objectives, intentions, assumptions and other statements that are not historical facts. Words or phrases such as “anticipate,” “believe,” “continue,” “ongoing,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “predict,” “project” or similar words or phrases, or the negatives of those words or phrases, may identify forward-looking statements, but the absence of these words does not necessarily mean that a statement is not forward-looking.
Forward-looking statements are subject to known and unknown risks and uncertainties and are based on our views, plans, estimates, and expectations. Potentially inaccurate assumptions could cause actual results to differ materially from those expected or implied by the forward-looking statements. Our actual results could differ materially from those anticipated in forward-looking statements for many reasons, including the factors described in Item 1A, “Risk Factors” in Part I of our Annual Report on Form 10-K for our fiscal year ended December 31, 2016. Accordingly, you should not unduly rely on these forward-looking statements, which speak only as of the date they are made. We undertake no obligation to publicly revise any forward-looking statements included in this Quarterly Report to reflect circumstances or events after the date of this Quarterly Report, or to reflect the occurrence of unanticipated events. You should, however, review the factors and risks we describe in the reports we will file from time to time with the Securities and Exchange Commission ("SEC"), after the date of this Quarterly Report on Form 10-Q.
Forward-looking statements include, but are not limited to, statements about:
our ability to respond to global economic, market, business and geopolitical conditions;
our anticipated future results of operations and operating cash flows;
our successful formulation and execution of business strategies and investment policies;
our financing plans and the availability of short- or long-term borrowing, or equity financing;
our competitive position and the effects of competition on our business;
our ability to identify and capture potential growth opportunities available to us;
the effective recruitment and retention of our key executives and employees;
our expected levels of compensation for our employees;
our potential operating performance, achievements, efficiency, and cost reduction efforts;
our expected tax rate;
changes in interest rates;
our expectations with respect to the economy, capital markets, the market for asset management services, and other industry trends; and
the impact of future legislation and regulation, and changes in existing legislation and regulation, on our business.
The reports that we file with the SEC, accessible on the SEC’s website at www.sec.gov, identify additional factors that can affect forward-looking statements.
PART I. FINANCIAL INFORMATION
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(in thousands, except share and per-share amounts)
Cash and Cash Equivalents ($3,403 and $3,258)1
Due from Broker ($820 and $0)1
Advisory Fees Receivable
Investments in Marketable Securities, at Fair Value ($4,736 and $3,174)1
Receivable from Related Parties
Other Receivables ($21 and $9)1
Prepaid Expenses and Other Assets
Deferred Tax Asset
Property and Equipment, Net of Accumulated Depreciation of $2,540 and $2,260, respectively
Accounts Payable and Accrued Expenses ($9 and $18)1
Due to Broker ($570 and $3)1
Securities Sold Short, at Fair Value
Liability to Selling and Converting Shareholders
Deferred Compensation Liability
Commitments and Contingencies (see Note 11)
Preferred Stock (Par Value $0.01; 200,000,000 Shares Authorized; None Outstanding)
Class A Common Stock (Par Value $0.01; 750,000,000 Shares Authorized; 17,285,307 and 17,340,090 Shares Issued and Outstanding in 2017 and 2016, respectively)
Class B Common Stock (Par Value $0.000001; 750,000,000 Shares Authorized; 51,109,592 and 50,461,598 Shares Issued and Outstanding in 2017 and 2016, respectively)
Total Pzena Investment Management, Inc.'s Equity
Non-Controlling Interests
Asset and liability amounts in parentheses represent the aggregated balances at June 30, 2017 and December 31, 2016 attributable to Pzena International Value Service (a series of Pzena Investment Management, LLC) and Pzena Investment Management Special Situations, LLC, which were variable interest entities as of June 30, 2017 and December 31, 2016, respectively.
See accompanying notes to unaudited consolidated financial statements.
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three Months Ended June 30,
For the Six Months Ended June 30,
Compensation and Benefits Expense
General and Administrative Expense
OTHER INCOME/ (EXPENSE)
Net Realized and Unrealized Gains/ (Losses) from Investments
Equity in Earnings/ (Losses) of Affiliates
Change in Liability to Selling and Converting Shareholders
Total Other Income/ (Expense)
Less: Net Income Attributable to Non-Controlling Interests
Net Income Attributable to Pzena Investment Management, Inc.
Net Income for Basic Earnings per Share
Basic Earnings per Share
Basic Weighted Average Shares Outstanding1
Net Income for Diluted Earnings per Share
Diluted Earnings per Share
Diluted Weighted Average Shares Outstanding1
Cash Dividends per Share of Class A Common Stock
The Company issues restricted shares of Class A common stock and restricted Class B units that have non-forfeitable dividend rights. Under the "two-class method," these shares and units are considered participating securities and are required to be included in the computation of basic and diluted earnings per share.
UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
OTHER COMPREHENSIVE GAIN/ (LOSS)
Foreign Currency Translation Adjustment
Total Other Comprehensive Gain/ (Loss)
Less: Comprehensive Income Attributable to Non-Controlling Interests
Total Comprehensive Income Attributable to Pzena Investment Management, Inc.
UNAUDITED CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
Paid-In Capital
Non-Controlling
Balance at December 31, 2016
Adjustment for the Cumulative Effect of Applying ASU 2016-09
Adjusted Balance at January 1, 2017
Amortization of Non-Cash Compensation
Issuance of Shares under Equity Incentive Plan
Sale of Shares under Equity Incentive Plan
Directors' Share Grants
Foreign Currency Translation Adjustments
Repurchase and Retirement of Class A Common Stock
(79,717
Repurchase and Retirement of Class B Units
Class A Cash Dividends Declared and Paid ($0.31 per share)
Contributions from Non-Controlling Interests
Distributions to Non-Controlling Interests
Balance at June 30, 2017
(1,369,811
Directors' Shares
Option Exercise
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
Adjustments to Reconcile Net Income to Cash
Provided by Operating Activities:
Loss on Disposal of Fixed Assets
Non-Cash Compensation
Due from Broker
Due to Broker
Accounts Payable, Accrued Expenses, and Other Liabilities
Purchases of Equity Securities and Securities Sold Short
Proceeds from Equity Securities and Securities Sold Short
Purchases of Investments
Proceeds from Sale of Investments
Payments to Related Parties
Purchases of Property and Equipment
Net Cash (Used in)/ Provided by Investing Activities
CASH AND CASH EQUIVALENTS - Beginning of Period
CASH AND CASH EQUIVALENTS - End of Period
Supplementary Cash Flow Information:
Issuances of Shares under Equity Incentive Plan
Income Taxes Paid
Notes to Unaudited Consolidated Financial Statements
Note 1—Organization
Pzena Investment Management, Inc. (the “Company”) is the sole managing member of its operating company, Pzena Investment Management, LLC (the “operating company”). As a result, the Company: (i) consolidates the financial results of the operating company and reflects the membership interests in the operating company that it does not own as a non-controlling interest in its consolidated financial statements; and (ii) recognizes income generated from its economic interest in the operating company’s net income.
The operating company is an investment adviser registered under the Investment Advisers Act of 1940 and is headquartered in New York, New York. As of June 30, 2017, the operating company managed 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.
The Company also serves as the general partner of Pzena Investment Management, LP, a partnership formed with the objective of aggregating employee ownership in the operating company into one entity.
The Company, through its interest in the operating company, has consolidated the results of operations and financial condition of the following entities as of June 30, 2017:
Ownership at
Type of Entity (Date of Formation)
Pzena Investment Management, Pty
Australian Proprietary Limited Company (12/16/2009)
Pzena Financial Services, LLC
Delaware Limited Liability Company (10/15/2013)
Pzena Investment Management, LTD
England and Wales Private Limited Company (01/08/2015)
Pzena Investment Management Special Situations, LLC
Pzena International Value Service, a series of Pzena Investment Management International, LLC
Pzena Long/Short Value Fund, a series of Advisors Series Trust
Open-end Management Investment Company, series of Delaware Statutory Trust (3/31/2014)
Pzena Mid Cap Value Fund, a series of Advisors Series Trust
Note 2—Significant Accounting Policies
Basis of Presentation:
Principles of Consolidation:
The consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and related Securities and Exchange Commission (“SEC”) rules and regulations. The Company’s policy is to consolidate those entities in which it has a direct or indirect controlling financial interest based on either the voting interest model or the variable interest model. As such, the Company consolidates majority-owned subsidiaries in which it has a controlling financial interest, and certain investment vehicles the operating company sponsors for which it is the investment adviser that are considered to be variable-interest entities (“VIEs”), and for which the Company is deemed to be the primary beneficiary.
Pursuant to the Consolidation Topic of the FASB Accounting Standards Codification (“FASB ASC”), for legal entities evaluated for consolidation, the Company determines whether interests it holds and fees paid to the entity qualify as a variable interest. If it is determined that the Company does not have a variable interest in the entity, no further analysis is required and the Company does not consolidate the entity. If it is determined that the Company has a variable interest, it considers its direct economic interests and the proportionate indirect interests through related parties to determine if it is the primary beneficiary of the VIE.
Notes to Unaudited Consolidated Financial Statements (Continued)
For equity investments where the Company does not control the investee, and where it is not the primary beneficiary of a VIE, but can exert significant influence over the financial and operating policies of the investee, the Company follows the equity method of accounting. The evaluation of whether the Company exerts control or significant influence over the financial and operating policies of the investee requires significant judgment based on the facts and circumstances surrounding each investment. Factors considered in these evaluations may include the type of investment, the legal structure of the investee, the terms of the investment agreement, or other agreements with the investee.
The Company analyzes entities structured as series funds which comply with the requirements included in the Investment Company Act of 1940 for registered mutual funds as voting interest entities because the shareholders are deemed to have the ability to direct the activities of the fund that most significantly impact the fund's economic performance.
Consolidated Entities
The Company consolidates the financial results of the operating company and records in its own equity its pro-rata share of transactions that impact the operating company’s net equity, including unit and option issuances, repurchases, and retirements. The operating company’s pro-rata share of such transactions are recorded as an adjustment to additional paid-in capital or non-controlling interests, as applicable, on the consolidated statements of financial condition.
The majority-owned subsidiaries in which the Company, through its interest in the operating company, has a controlling financial interest and the VIEs for which the Company is deemed to be the primary beneficiary are collectively referred to as “consolidated subsidiaries.” Non-controlling interests recorded on the consolidated financial statements of the Company include the non-controlling interests of the outside investors in each of these entities, as well as those of the operating company. All significant inter-company transactions and balances have been eliminated through consolidation.
During 2014, the Company provided the initial cash investment for three Pzena mutual funds in an effort to generate an investment performance track record to attract third-party investors. During 2016, the Company provided the initial cash investment for the launch of a fourth Pzena mutual fund: the Pzena Small Cap Value Fund. Due to their series fund structure, registration, and compliance with the requirements of the Investment Company Act of 1940, these funds are analyzed for consolidation under the voting interest model. As a result of the Company's initial interests, it consolidated the Pzena Mid Cap Value Fund, Pzena Long/Short Value Fund, Pzena Emerging Markets Value Fund, and Pzena Small Cap Value Fund. On July 11, 2016, due to additional subscriptions into the Pzena Small Cap Value Fund, the Company's ownership decreased to 36.1%. As the entity was no longer deemed to control the fund, the Company deconsolidated the entity, removed the related assets, liabilities and non-controlling interest from its balance sheet and classified the Company's remaining investment as an equity method investment. Upon adoption of ASU No. 2015-02 as of January 1, 2016, the Company was deemed to not have a controlling interest in the Pzena Emerging Markets Value Fund. The Pzena Mid Cap Value Fund and Pzena Long/Short Value Fund will continue to be consolidated to the extent the Company has a majority ownership interest in them. At June 30, 2017, the aggregate of these funds' $11.9 million in net assets was included in the Company's consolidated statements of financial condition.
The operating company is the managing member of Pzena International Value Service, a series of Pzena Investment Management International, LLC. The operating company is considered the primary beneficiary of this entity. At June 30, 2017, Pzena International Value Service’s $4.9 million in net assets was included in the Company’s consolidated statements of financial condition.
These consolidated mutual funds and investment partnerships are investment companies and apply specialized industry accounting for investment companies. The Company has retained this specialized accounting for these mutual funds and investment partnerships pursuant to U.S. GAAP.
Non-Consolidated Variable Interest Entities
VIEs that are not consolidated receive investment management services from the operating company and are generally private investment partnerships sponsored by the operating company. The total net assets of these VIEs was approximately $47.4 million and $44.3 million at June 30, 2017 and December 31, 2016, respectively.
As of June 30, 2017 and December 31, 2016, in order to satisfy certain of the Company's obligations under its deferred compensation programs, the operating company had $3.0 million and $3.2 million in investments, respectively, in certain of these firm-sponsored vehicles, for which the Company was not deemed to be the primary beneficiary. The Company's exposure to risk in the non-consolidated VIEs is generally limited to any equity investment and any uncollected management fees. As of
June 30, 2017 and December 31, 2016, the Company's maximum exposure to loss as a result of its involvement with the non-consolidated VIEs was $3.1 million and $3.3 million, respectively.
Accounting Pronouncements Adopted in 2017:
In March 2016, the FASB issued ASU No. 2016-09, "Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting." The Company adopted ASU No. 2016-09 as of January 1, 2017. This standard requires excess tax benefits and tax deficiencies to be recorded in the consolidated statements of operations as a component of Income Tax Expense/ (Benefit) when equity awards vest or are settled. The Company is no longer required to delay recognition of an excess tax benefit until it reduces current taxes payable. The standard also requires excess tax benefits to be classified as operating activities along with other income tax cash flows within the consolidated statements of cash flows. In addition, ASU No. 2016-09 allows entities to make an accounting policy election to either estimate the number of forfeitures expected to occur, as was previously required, or to account for actual forfeitures as they occur. The Company has elected to account for forfeitures as they occur, rather than estimate expected forfeitures.
The adoption of ASU No. 2016-09 resulted in a net cumulative effect adjustment reflecting a $1.4 million increase to retained earnings and the deferred tax asset as of January 1, 2017, related to the recognition of the previously unrecognized excess tax benefits using the modified retrospective method. Estimates of forfeitures in prior periods were immaterial, and therefore are not included in the cumulative effect adjustment. The amendments related to the classification of the excess tax benefits in the consolidated statements of cash flows were adopted on a prospective basis, which did not require the restatement of prior periods.
Management’s Use of Estimates:
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses for the period. Actual results could materially differ from those estimates.
Revenue Recognition:
Revenue, comprised of advisory fee income, is recognized over the period in which advisory services are provided. Advisory fee income includes management fees that are calculated based on percentages of assets under management (“AUM”), generally billed quarterly, either in arrears or advance, depending on the applicable contractual terms. Advisory fee income also includes performance fees that may be earned by the Company depending on the investment return of the AUM, as well as fulcrum fee arrangements. Performance fee arrangements generally entitle the Company to participate, on a fixed-percentage basis, in any returns generated in excess of an agreed-upon benchmark. The Company’s participation percentage in such return differentials is then multiplied by AUM to determine the performance fees earned. In general, returns are calculated on an annualized basis over the contract’s measurement period, which usually extends to three years. Performance fees are generally payable annually. 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 over the contract's measurement period, which extends to three years. Fulcrum fees are generally payable quarterly. Following the preferred method identified in the Revenue Recognition Topic of the FASB ASC, performance fee income is recorded at the conclusion of the contractual performance period, when all contingencies are resolved. For the three and six months ended June 30, 2017, the Company recognized $0.4 million and $0.7 million in performance fee income. The Company did not recognize performance fee income during three months ended June 30, 2016. For the six months ended June 30, 2016 the Company recognized approximately $0.1 million in performance fee income. For the three months ended June 30, 2017, the Company did not recognize a reduction in base fees related to fulcrum fee arrangements. For the six months ended June 30, 2017, the Company recognize a $0.1 million reduction in base fees related to fulcrum fee arrangements. For the three and six months ended June 30, 2016, the Company did not recognize a reduction in base fees related to fulcrum fee arrangements.
At June 30, 2017 and December 31, 2016, Cash and Cash Equivalents was $34.7 million and $43.5 million, respectively. The Company considers all highly-liquid debt instruments with an original maturity of three months or less at the time of purchase to be cash equivalents. The Company maintains its cash in bank deposits and other accounts whose balances often exceed federally insured limits.
Interest on cash and cash equivalents is recorded as interest income on an accrual basis in the consolidated statements of operations.
Restricted Cash:
At June 30, 2017 and December 31, 2016, the Company had $4.3 million and $3.6 million, respectively, of compensating balances recorded in Restricted Cash in the consolidated statements of financial condition.
Included in these balances at June 30, 2017 and December 31, 2016, is a $1.0 million letter of credit issued by a third party in lieu of a cash security deposit, as required by the Company’s lease for its corporate headquarters.
Also included in these balances at June 30, 2017 and December 31, 2016, were amounts of cash collateral for margin accounts established by the Pzena Long/Short Value Fund required to maintain to support securities sold short, not yet purchased of $3.3 million and $2.6 million, respectively.
Due to/from Broker:
Due to/from Broker consists primarily of amounts payable/receivable for unsettled securities transactions held/initiated at the clearing brokers of the Company’s consolidated subsidiaries.
Non-Cash Compensation:
All non-cash compensation awards granted have varying vesting schedules and are issued at prices equal to the assessed fair market value at the time of issuance. Expenses associated with these awards are recognized over the period during which employees are required to provide service. The Company accounts for forfeitures as they occur.
Investments:
Investment Securities, trading
Investments classified as trading securities consist of equity securities held by the Company and its consolidated subsidiaries. Dividends associated with the Company's investments and the investments of the Company's consolidated subsidiaries are recognized as dividend income on an ex-dividend basis in the consolidated statements of operations.
Securities Sold Short represents securities sold short, not yet purchased by the Pzena Long/Short Value Fund, which is consolidated with the Company's financial statements. Dividend expense associated with these investments is recognized in Other Income/ (Expense) on an ex-dividend basis in the consolidated statements of operations.
All such investments are recorded at fair value, with net realized and unrealized gains and losses reported in earnings. Net realized and unrealized gains and losses are recognized as a component of Net Realized and Unrealized Gains/ (Losses) from Investments in the consolidated statements of operations.
Investments in equity method investees
During the three and six months ended June 30, 2017, the Company accounted for its investments in certain private investment partnerships, the Pzena Emerging Markets Value Fund and the Pzena Small Cap Value Fund, in which the Company has non-controlling interests and exercises significant influence, using the equity method. These investments are included in Investments in the Company's consolidated statements of financial condition. The carrying value of these investments are recorded at the amount of capital reported by the private investment partnership or mutual fund. The capital account for each entity reflects any contributions paid to, distributions received from, and equity earnings of, the relevant entity. The earnings of these investments are recognized as equity in the earnings of affiliates and reflected as a component of Equity in Earnings/ (Losses) of Affiliates in the consolidated statements of operations.
Investments in equity method investees are evaluated for impairment as events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. If the carrying amounts of the assets exceed their respective fair values, additional impairment tests are performed to measure the amounts of impairment losses, if any. During the three and six months ended June 30, 2017 and 2016, no impairment losses were recognized.
Securities Valuation:
Investments in equity securities and securities sold short for which market quotations are available are valued at the last reported price or closing price on the primary market or exchange on which they trade. If no reported equity sales occurred on the valuation date, equity investments are valued at the bid price. Transactions are recorded on a trade date basis.
The net realized gain or loss on sales of equity securities and securities sold short is determined on a specific identification basis and is included in Net Realized and Unrealized Gains/ (Losses) from Investments in the consolidated statements of operations.
Concentrations of Credit Risk:
Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents, amounts due from brokers, and advisory fees receivable. The Company maintains its cash and cash equivalents in bank deposits and other accounts whose balances often exceed federally insured limits.
The concentration of credit risk with respect to advisory fees receivable is generally limited due to the short payment terms extended to clients by the Company. On a periodic basis, the Company evaluates its advisory fees receivable and establishes an allowance for doubtful accounts, if necessary, based on a history of past write-offs, collections, and current credit conditions. For both the three and six months ended June 30, 2017, approximately 11.1% of the Company's advisory fees were generated from advisory agreements with one client relationship. For the three and six months ended June 30, 2016, approximately 11.0% and 10.9% of the Company's advisory fees, respectively, were generated from advisory agreements with one client relationship. At June 30, 2017 and December 31, 2016, there was no allowance for doubtful accounts.
Property and Equipment:
Property and equipment is carried at cost, less accumulated depreciation and amortization. Depreciation is provided on a straight-line basis over the estimated useful lives of the respective assets, except for leasehold improvements, which range from three to seven years. Leasehold improvements are amortized on a straight-line basis over the shorter of the useful life of the improvements or the remaining lease term.
Business Segments:
The Company views its operations as comprising one operating segment.
Income Taxes:
The Company is a “C” corporation under the Internal Revenue Code, and thus liable for federal, state, and local taxes on the income derived from its economic interest in its operating company. The operating company is a limited liability company that has elected to be treated as a partnership for tax purposes. It has not made a provision for federal or state income taxes because it is the individual responsibility of each of the operating company’s members (including the Company) to separately report their proportionate share of the operating company’s taxable income or loss. 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 effective tax rate for interim periods represents the Company’s best estimate of the effective tax rate expected to be applied to the full fiscal year, adjusted for discrete items recognized during the quarter.
Judgment is required in evaluating the Company's uncertain tax positions and determining its provision for income taxes. The Company establishes liabilities for tax-related uncertainties based on estimates of whether, and the extent to which, additional taxes will be due. These liabilities are established when the Company believes that certain positions might be challenged despite its belief that its tax return positions are in accordance with applicable tax laws. The Company adjusts these liabilities in light of changing facts and circumstances, such as the closing of a tax audit, new tax legislation or the change of an estimate. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made. The provision for income taxes includes the effect of reserve provisions and changes to reserves that are considered appropriate. It is also the Company’s policy to recognize accrued interest, and penalties associated with uncertain tax positions in Income Tax Expense on the consolidated statements of operations.
The Company and its consolidated subsidiaries account for all U.S. federal, state, local, and U.K. taxation pursuant to the asset and liability method, which requires deferred income tax assets and liabilities to be recorded for temporary differences between the carrying amount and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future, based on enacted tax laws and rates applicable to the periods in which the temporary differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount more-likely-than-not to be realized. At June 30, 2017, the Company did not have a valuation allowance recorded against its deferred tax assets.
The income tax expense, or benefit, is the tax payable or refundable for the period, plus or minus the change during the period in deferred tax assets and liabilities. The Company records its deferred tax liabilities as a component of other liabilities in the consolidated statements of financial condition.
Upon adoption of ASU No. 2016-09 as of January 1, 2017, all excess tax benefits or tax deficiencies related to stock- and unit-transactions are reflected in the consolidated statements of operations as a component of the provision for income taxes. Previously, these excess tax benefits were not recognized until they resulted in a reduction of cash taxes payable, and were subsequently recorded in equity when they reduced cash taxes payable. The Company only recognized a tax benefit from stock- and unit-based awards in Additional Paid-In Capital if an incremental tax benefit was realized after all other tax benefits available had been utilized. The adoption of ASU No. 2016-09 resulted in a net cumulative effect adjustment reflecting a $1.4 million increase to retained earnings and the deferred tax asset as of January 1, 2017, related to the recognition of the previously unrecognized excess tax benefits using the modified retrospective method.
Tax Receivable Agreement:
The Company’s purchase of membership units of the operating company concurrent with the initial public offering, and the subsequent and future exchanges by holders of Class B units of the operating company for shares of Class A common stock (pursuant to the exchange rights provided for in the operating company’s operating agreement), have resulted in, and are expected to continue to result in, increases in the Company’s share of the tax basis of the tangible and intangible assets of the operating company, which will increase the tax depreciation and amortization deductions that otherwise would not have been available to the Company. These increases in tax basis and tax depreciation and amortization are each deductible for tax purposes over a period of 15 years and have reduced, and are expected to continue to reduce, the amount of cash taxes that the Company would otherwise be required to pay in the future. The Company has entered into a tax receivable agreement with past, current, and future members of the operating company that requires the Company to pay to any member involved in any exchange transaction 85% of the amount of cash tax savings, if any, in U.S. federal, state and local income tax or foreign or franchise tax that it realizes as a result of these increases in tax basis and, in limited cases, transfers or prior increases in tax basis. The Company expects to benefit from the remaining 15% of cash tax savings, if any, in income tax it realizes. Payments under the tax receivable agreement will be based on the tax reporting positions that the Company will determine. The Company will not be reimbursed for any payments previously made under the tax receivable agreement if a tax basis increase is successfully challenged by the Internal Revenue Service.
The Company records an increase in deferred tax assets for the estimated income tax effects of the increases in tax basis based on enacted federal and state tax rates at the date of the exchange. The Company records 85% of the estimated realizable tax benefit (which is the recorded deferred tax asset less any recorded valuation allowance) as an increase to the liability due under the tax receivable agreement, which is reflected as the liability to selling and converting shareholders in the accompanying consolidated financial statements. The remaining 15% of the estimated realizable tax benefit is initially recorded as an increase to the Company’s additional paid-in capital. All of the effects to the deferred tax asset of changes in any of the estimates after the tax year of the exchange will be reflected in the provision for income taxes. Similarly, the effect of subsequent changes in the enacted tax rates will be reflected in the provision for income taxes.
If the Company exercises its right to terminate the tax receivable agreement early, the Company will be obligated to make an early termination payment to the selling and converting shareholders, based upon the net present value (based upon certain assumptions and deemed events set forth in the tax receivable agreement) of all payments that would be required to be paid by the Company under the tax receivable agreement. If certain change of control events were to occur, the Company would be obligated to make an early termination payment.
Foreign Currency:
The functional currency of the Company is the U.S. Dollar. Assets and liabilities of foreign operations whose functional currency is not the U.S. Dollar are translated at the exchange rate in effect at the applicable reporting date, and the consolidated statements of operations are translated at the average exchange rates in effect during the applicable period. A charge or credit is recorded to other comprehensive income/ (loss) to reflect the translation of these amounts to the extent the non-U.S. currency is designated the functional currency of the subsidiary. Non-functional currency related transaction gains and losses are immediately recorded in the consolidated statements of operations. For the three and six months ended June 30, 2017, the Company recorded less than $0.1 million and $0.1 million, respectively, of other comprehensive income associated with foreign currency translation adjustments. For the three and six months ended June 30, 2016, the Company recorded less than $0.1 million of such income.
Investment securities and other assets and liabilities denominated in foreign currencies are remeasured into U.S. Dollar amounts at the date of valuation. Purchases and sales of investment securities, and income and expense items denominated in foreign currencies, are remeasured into U.S. Dollar amounts on the respective dates of such transactions.
The Company does not isolate the portion of the results of its operations resulting from the impact of fluctuations in foreign exchange rates on its non-U.S. investments. Such fluctuations are included in Net Realized and Unrealized Gains/ (Losses) from Investments in the consolidated statements of operations.
Reported net realized foreign exchange gains or losses arise from sales of foreign currencies, currency gains or losses realized between the trade and settlement dates on securities transactions, and the difference between the amounts of dividends, interest, foreign withholding taxes, and other receivables and payables recorded on the Company’s consolidated statements of financial condition and the U.S. Dollar equivalent of the amounts actually received or paid. Net unrealized foreign exchange gains and losses arise from changes in the fair values of assets and liabilities resulting from changes in exchange rates.
Recently Issued Accounting Pronouncements Not Yet Adopted:
In November 2016, the FASB issued ASU No. 2016-18, "Statement of Cash Flows (Topic 230): Restricted Cash." This update requires entities to show the changes in the total cash, cash equivalents, restricted cash, and restricted cash equivalents in the statement of cash flows. This guidance is effective for the fiscal years and interim periods within those years beginning after December 15, 2017. The guidance should be applied using a retrospective approach. Upon adoption, the net change in cash presented in the consolidated statement of cash flows will reflect the total of cash, cash equivalents, and restricted cash.
In August 2016, the FASB issued ASU No. 2016-15, "Statement of Cash Flows (Topic 230)." This update provides specific guidance on cash flow classification issues, which is intended to reduce the diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The guidance is effective for the fiscal years and interim periods within those years beginning after December 15, 2017. The guidance should be applied using a modified retrospective approach. The Company is assessing the impact this standard will have on the consolidated financial statements and related disclosures.
In June 2016, the FASB issued ASU No. 2016-13, "Financial Instruments - Credit Losses (Topic 326)." This new guidance requires the use of an “expected loss” model, rather than an “incurred loss” model, for financial instruments measured at amortized cost and also requires companies to record allowances for available-for-sale debt securities rather than reduce the carrying amount. The guidance is effective for the fiscal years and interim periods within those years beginning after December 15, 2019. The guidance should be applied using a retrospective approach. The Company is currently assessing the impact of this standard, however, does not expect the standard to have a material impact on the consolidated financial statements.
In February 2016, the FASB issued ASU No. 2016-02, "Leases (Topic 842)." This amended standard was written to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The new standard requires lessees to recognize a right-of-use asset and lease liability for all leases with terms of more than 12 months. Recognition, measurement and presentation of expenses will depend on classification as a finance or operating lease. The amendments also require certain quantitative and qualitative disclosure. Accounting guidance for lessors is largely unchanged. This guidance is effective for the fiscal years and interim periods within those years beginning after December 15, 2018, and requires a modified retrospective approach to adoption. The Company is currently evaluating the impact of adoption on its consolidated financial statements. The standard is expected to result in an increase in total assets and total liabilities, but will not have a significant impact on the consolidated statement of operations.
In May 2014, the FASB issued ASU No. 2014-09, "Revenue from Contracts with Customers (Topic 606)." The core principle of the revenue model is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for the goods or services. In July 2015, the FASB postponed the effective date of this new guidance from January 1, 2017 to January 1, 2018. Early application is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. The Company is currently evaluating its transition method and continues to assess the impact of adoption. While we have not identified material changes in the timing of revenue recognition, we continue to evaluate the presentation of certain revenue related costs on a gross versus net basis as well as the additional disclosures required by the standard. However, based on current evaluations, the Company does not expect the adoption to have a material impact on its consolidated financial statements.
Note 3—Compensation and Benefits
Compensation and benefits expense to employees and members is comprised of the following:
Cash Compensation and Other Benefits
Total Compensation and Benefits Expense
All non-cash compensation awards granted have varying vesting schedules and are issued at prices equal to the assessed fair market value at the time of issuance, as discussed below. No new non-cash compensation awards were issued during the three months ended June 30, 2017 and 2016. Details of non-cash compensation awards granted during the six months ended June 30, 2017 and 2016 are as follows:
Restricted Class B Units
Options to Purchase Shares of Class A Common Stock2
Options to Purchase Delayed Exchange Class B Units3
Options to Purchase Class B Units2
Deferred Compensation Phantom Delayed Exchange Class B Units4
Represents the grant date fair value per share, unit, or option.
Represents options to purchase shares of Class A common stock or Class B units. These options become exercisable five years from the date of grant.
Represents options to purchase Delayed Exchange Class B units issued under 2006 Equity Incentive Plan (as defined below). These options become exercisable five years from the date of grant. Upon exercise, the resulting Delayed Exchange Class B units may not be exchanged pursuant the Amended and Restated Operating Agreement until the seventh anniversary of the exercise date and are not entitled to any benefits under the Tax Receivable Agreement.
Represents phantom Delayed Exchange Class B units issued under the Bonus Plan (as defined below). These units vest ratably over four years and become Delayed Exchange Class B units upon vesting which may not be exchanged pursuant the Amended and Restated Operating Agreement until the seventh anniversary of the vesting date and are not entitled to any benefits under the Tax Receivable Agreement.
As part of the Company's year-end bonus structure, certain employee members may elect to have all or part of year-end cash compensation paid in the form of cash, or equity issued pursuant to Pzena Investment Management, LLC Amended and Restated 2006 Equity Incentive Plan (“the 2006 Equity Incentive Plan”). For the year ended December 31, 2016, $4.5 million of cash compensation was elected to be paid in the form of equity, which was issued and vested immediately on January 1, 2017. Details of awards associated with these elections issued on January 1, 2017 are as follows:
January 1,
Fair Value1
Phantom Class B Units2
Delayed Exchange Class B Units3
Represents the grant date fair value per share or unit.
Represents phantom Class B units issued under the 2006 Equity Incentive Plan. These phantom units vest ratably over ten years starting immediately and are not entitled to receive dividend or dividend equivalents until vested.
Represents Class B units issued under the 2006 Equity Incentive Plan. These units vest immediately upon grant, but may not be exchanged pursuant to the Amended and Restated Operating Agreement of the operating company until the seventh anniversary of the date of grant. These units are also not entitled to any benefits under the Tax Receivable Agreement between the Company and members of the operating company.
Pursuant to the 2006 Equity Incentive Plan, the operating company issues Class B units, phantom Class B units and options to purchase Class B units. The operating company also issues Delayed Exchange Class B units pursuant to the 2006 Equity Incentive Plan. These Delayed Exchange Class B units vest immediately upon grant, but may not be exchanged pursuant to the Amended and Restated Operating Agreement of the operating company until at least the seventh anniversary of the date of grant. These Delayed Exchange Class B units are also not entitled to any benefit under the Tax Receivable Agreement between the Company and members of the operating company. Under the Pzena Investment Management, Inc. 2007 Equity Incentive Plan (“the 2007 Equity Incentive Plan”), the Company issues shares of restricted Class A common stock and contingently vesting options to acquire shares of Class A common stock. During each of the three and six months ended June 30, 2017 and 2016, no contingently vesting options vested. During the three months ended June 30, 2017 and 2016, 9,789 and 57,283 Delayed Exchange Class B units were issued to certain employee members, respectively, for approximately $0.1 million and $0.3 million in cash, respectively. During the six months ended June 30, 2017 and 2016, 13,677 and 69,978 Delayed Exchange Class B units were issued to certain employee members, respectively, for approximately $0.1 million and $0.3 million in cash, respectively.
Under the Pzena Investment Management, LLC Amended and Restated Bonus Plan (the “Bonus Plan”), eligible employees whose compensation is in excess of certain thresholds are required to defer a portion of that excess. These deferred amounts may be invested, at the employee’s discretion, in certain investment options designated by the Compensation Committee of the Company's Board of Directors. Amounts deferred in any calendar year reduce that year’s compensation expense and are amortized and vest ratably over a four-year period commencing the following year. The Company also issued to certain of its employees deferred compensation with certain investment options that also vest ratably over a four-year period. As of both June 30, 2017 and December 31, 2016, the liability associated with all deferred compensation investment accounts was $2.2 million and $4.2 million, respectively.
Pursuant to the Pzena Investment Management, Inc. Non-Employee Director Deferred Compensation Plan (the “Director Plan”), non-employee directors may elect to have all or part of their compensation otherwise payable in cash, deferred in the form of phantom shares of Class A common stock of the Company issued under the 2007 Equity Incentive Plan. Elections to defer compensation under the Director Plan are made on a year-to-year basis. Distributions under the Director Plan are made in a single distribution of shares of Class A common stock at such time as elected by the participant when the deferral was made. Since inception of the Director Plan in 2009, the Company’s directors have elected to defer 100% of their compensation in the form of phantom shares of Class A common stock. Amounts deferred in any calendar year are amortized over the calendar year and reflected as General and Administrative Expense. As of June 30, 2017 and December 31, 2016, there were 334,133 and 291,230 phantom shares of Class A common stock outstanding, respectively. For the three and six months ended June 30, 2017 and 2016, no distributions were made under the Director Plan.
As of June 30, 2017 and December 31, 2016, the Company had approximately $33.7 million and $30.0 million, respectively, in unrecorded compensation expense related to unvested awards issued pursuant to its Bonus Plan and certain
agreements; Class B units, Delayed Exchange Class B units, and phantom Class B units issued under the 2006 Equity Incentive Plan; and restricted Class A common stock and contingently vesting option grants issued under the 2007 Equity Incentive Plan. The Company anticipates that this unrecorded cost will amortize over the respective vesting periods of the awards.
Note 4 – Employee Benefit Plans
The operating company has a Profit Sharing and Savings Plan for the benefit of substantially all employees. The Profit Sharing and Savings Plan is a defined contribution profit sharing plan with a 401(k) deferral component. All full-time employees and certain part-time employees who have met the age and length of service requirements are eligible to participate in the plan. The plan allows participating employees to make elective deferrals of compensation up to the annual limits which are set by law. The plan provides for a discretionary annual contribution by the operating company which is determined by a formula based on the salaries of eligible employees as defined by the plan. For the three and six months ended June 30, 2017, the expense recognized in connection with this plan was $0.1 million and $0.8 million, respectively. For the three and six months ended June 30, 2016, the expense recognized in connection with this plan was $0.2 million and $0.6 million, respectively.
Note 5—Earnings per Share
Basic earnings per share is computed by dividing the Company’s net income attributable to its common stockholders by the weighted average number of shares outstanding during the reporting period.
Under the two-class method of computing basic earnings per share, basic earnings per share is calculated by dividing net income for basic earnings per share by the weighted average number of common shares outstanding during the period. The two-class method includes an earnings allocation formula that determines earnings per share for each participating security according to dividends declared and undistributed earnings for the period. The Company’s net income for basic earnings per share is reduced by the amount allocated to participating restricted shares of Class A common stock which participate for purposes of calculating earnings per share.
For the three and six months ended June 30, 2017 and 2016, the Company’s basic earnings per share was determined as follows:
(in thousands, except share and per share amounts)
Net Income for Basic Earnings per Share Allocated to:
Class A Common Stock
Participating Shares of Restricted Class A Common Stock
Total Net Income for Basic Earnings per Share
Basic Weighted-Average Shares Outstanding
Add: Participating Shares of Restricted Class A Common Stock1
Total Basic Weighted-Average Shares Outstanding
Certain unvested shares of Class A common stock granted to employees have nonforfeitable rights to dividends and therefore participate fully in the results of the Company from the date they are granted. They are included in the computation of basic earnings per share using the two-class method for participating securities.
Diluted earnings per share adjusts this calculation to reflect the impact of all outstanding membership units of the operating company, phantom Class B units, phantom Delayed Exchange Class B units, phantom Class A common stock, outstanding Class B unit options, options to purchase Class A common stock, and restricted Class A common stock, to the extent they would have a dilutive effect on net income per share for the reporting period. Net income for diluted earnings per share assumes that all outstanding operating company membership units are converted into Company stock at the beginning of the reporting period and the resulting change to the Company's net income associated with its increased interest in the operating company is taxed at the Company’s effective tax rate, exclusive of one-time charges and adjustments associated with both the valuation allowance and the liability to selling and converting shareholders and other one-time charges.
For the three and six months ended June 30, 2017 and 2016, the Company’s diluted net income was determined as follows:
Net Income Attributable to Non-Controlling Interests of Pzena Investment Management, LLC
Less: Assumed Corporate Income Taxes
Assumed After-Tax Income of Pzena Investment Management, LLC
Net Income of Pzena Investment Management, Inc.
Diluted Net Income
Under the two-class method of computing diluted earnings per share, diluted earnings per share is calculated by dividing net income for diluted earnings per share by the weighted average number of common shares outstanding during the period, plus the dilutive effect of any potential common shares outstanding during the period using the more dilutive of the treasury method or two-class method. The two-class method includes an earnings allocation formula that determines earnings per share for each participating security according to dividends declared and undistributed earnings for the period. The Company’s net income for diluted earnings per share is reduced by the amount allocated to participating restricted Class B units for purposes of calculating earnings per share. Dividend equivalent distributions paid per share on the operating company’s unvested restricted Class B units are equal to the dividends paid per Company Class A common stock.
For the three and six months ended June 30, 2017 and 2016, the Company’s diluted earnings per share were determined as follows:
(in thousands, except share and
per share amounts)
Diluted Net Income Allocated to:
Participating Class B Units
Total Diluted Net Income Attributable to Shareholders
Dilutive Effect of Class B Units
Dilutive Effect of Options 1
Dilutive Effect of Phantom Class B Units & Phantom Shares of Class A Common Stock
Dilutive Effect of Restricted Shares of Class A Common Stock 2
Dilutive Weighted-Average Shares Outstanding
Add: Participating Class B Units3
Total Dilutive Weighted-Average Shares Outstanding
Represents the dilutive effect of options to purchase operating company Class B units and Company Class A common stock.
Certain restricted shares of Class A common stock granted to employees are not entitled to dividend or dividend equivalent payments until they are vested and are therefore non-participating securities and are not included in the computation of basic earnings per share. They are included in the computation of diluted earnings per share when the effect is dilutive using the treasury stock method.
Unvested Class B Units granted to employees have nonforfeitable rights to dividend equivalent distributions and therefore participate fully in the results of the operating company's operations from the date they are granted. They are included in the computation of diluted earnings per share using the two-class method for participating securities.
Approximately 0.7 million options to purchase Class B units, 0.1 million options to purchase shares of Class A common stock, and 3.0 million contingent options to purchase shares of Class A common stock were excluded from the calculation of diluted earnings per share for the three and six months ended June 30, 2017, as their inclusion would have had an antidilutive effect based on current market prices or because the option had contingent vesting requirements. Approximately 0.6 million and 1.0 million options to purchase Class B units were excluded from the calculation of diluted earnings per share for the three and six months ended June 30, 2016, respectively, as their inclusion would have had an antidilutive effect based on current market prices. Approximately 0.7 million options to purchase shares of Class A common stock and 3.0 million contingent options to purchase shares of Class A common stock were also excluded from the calculation of diluted earnings per share for the three and six months ended June 30, 2016, as their inclusion would have had an antidilutive effect based on current market prices or because the option had contingent vesting requirements.
Note 6—Shareholders’ Equity
The Company functions as the sole managing member of the operating company. As a result, the Company: (i) consolidates the financial results of the operating company and reflects the membership interest in it that it does not own as a non-controlling interest in its consolidated financial statements; and (ii) recognizes income generated from its economic interest in the operating company’s net income. Class A and Class B units of the operating company have the same economic rights per unit. As of June 30, 2017, the holders of Class A common stock of the Company and the holders of Class B units of the operating company held approximately 25.3% and 74.7%, respectively, of the economic interests in the operations of the business. As of December 31, 2016, the holders of Class A common stock of the Company and the holders of Class B units of the operating company held approximately 25.6% and 74.4%, respectively, of the economic interests in the operations of the business.
Each Class B unit of the operating company is issued with a corresponding share of the Company’s Class B common stock, par value $0.000001 per share. Holders of Class B common stock have the right to receive the par value of the Class B common stock held by them upon our liquidation, dissolution or winding up, but do not share in dividends. Each share of the Company’s Class B common stock entitles its holder to five votes, until the first time that the number of shares of Class B common stock outstanding constitutes less than 20% of the number of all shares of the Company’s common stock outstanding. From such time and thereafter, each share of the Company’s Class B common stock entitles its holder to one vote. When a Class B unit is exchanged for a share of the Company’s Class A common stock or forfeited, a corresponding share of the Company’s Class B common stock will automatically be redeemed and canceled. Conversely, to the extent that the Company causes the operating company to issue additional Class B units to employees pursuant to its equity incentive plan, these additional holders of Class B units would be entitled to receive a corresponding number of shares of the Company’s Class B common stock (including if the Class B units awarded are subject to vesting).
All holders of the Company’s Class B common stock have entered into a stockholders’ agreement, pursuant to which they agreed to vote all shares of Class B common stock then held by them, with the majority of votes of Class B common stockholders taken in a preliminary vote of the Class B common stockholders.
The outstanding shares of the Company’s Class A common stock represent 100% of the rights of the holders of all classes of the Company’s capital stock to receive distributions, except that holders of Class B common stock will have the right to receive the class’s par value upon the Company’s liquidation, dissolution or winding up.
Pursuant to the operating agreement of the operating company, each vested Class B unit is exchangeable for a share of the Company’s Class A common stock, subject to certain exchange timing and volume limitations. These acquisition of additional operating company membership was treated as a reorganization of entities under common control as required by the Business Combinations Topic of the FASB ASC.
The Company’s share repurchase program was announced on April 24, 2012. The Board of Directors authorized the Company to repurchase up to an aggregate of $10 million of the Company’s outstanding Class A common stock and the operating company’s Class B units on the open market and in private transactions in accordance with applicable securities laws. On February 11, 2014, the Company announced that its Board of Directors approved an increase of $20 million in the aggregate amount authorized under the program. The timing, number and value of common shares and units repurchased are subject to the Company’s discretion. The Company’s share repurchase program is not subject to an expiration date and may be suspended, discontinued, or modified at any time, for any reason.
During the six months ended June 30, 2017, the Company purchased and retired 79,717 shares of Class A common stock and 2,897 Class B units under the current repurchase authorization at a weighted average price per share of $8.88 and $11.11, respectively. During the six months ended June 30, 2016, the Company purchased and retired 190,780 shares of Class A common stock and 8,574 Class B units under the repurchase authorization at a weighted average price per unit of $7.89 and $7.81, respectively. The Company records the repurchase of shares and units at cost based on the trade date of the transaction.
During the six months ended June 30, 2016, 37,039 Class B unit options exercised resulted in the issuance of 13,576 net Class B units as a result of the redemption of 23,463 Class B units for the cashless exercise of options. No options were exercised during the six months ended June 30, 2017.
Note 7—Non-Controlling Interests
Net Income Attributable to Non-Controlling Interests in the operations of the Company’s operating company and consolidated subsidiaries is comprised of the following:
Non-Controlling Interests of Pzena Investment Management, LLC
Non-Controlling Interests of Consolidated Subsidiaries
Net Income Attributable to Non-Controlling Interests
Distributions to non-controlling interests represent tax allocations and dividend equivalents paid to the members of the operating company, as well as withdrawals from the Company’s consolidated subsidiaries. Contributions from non-controlling interests represent contributions to the Company's consolidated subsidiaries.
Note 8—Investments
The following is a summary of Investments:
Total Investment Securities, Trading
Investments, at Fair Value consisted of the following at June 30, 2017:
Securities Sold Short, at Fair Value consisted of the following at June 30, 2017:
(Gain)/ Loss
Securities Sold Short
Investments, at Fair Value consisted of the following at December 31, 2016:
Securities Sold Short, at Fair Value consisted of the following at December 31, 2016:
The operating company sponsors and provides investment management services to certain private investment partnerships and Pzena mutual funds through which it offers its investment strategies. The Company has made investments in certain of these private investment partnerships and mutual funds to satisfy its obligations under the Company's deferred compensation program and provide the initial cash investment in our mutual funds. The Company holds a non-controlling interest and exercises significant influence in these entities, and accounts for its investments as equity method investments which are included in Investments on the consolidated statements of financial condition. On July 11, 2016, due to additional subscriptions into the Pzena Small Cap Value Fund, the Company's ownership decreased to 36.1%. As the entity was no longer deemed to control the fund, the Company deconsolidated the entity, removed the related assets, liabilities and non-controlling interest from its balance sheet and classified the Company's remaining investment as an equity method investment. As of June 30, 2017, the Company's investments range between 4% and 21% of the capital of these entities and have an aggregate carrying value of $8.1 million.
Note 9—Fair Value Measurements
The Fair Value Measurements and Disclosures Topic of the FASB ASC defines fair value as the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date. The Fair Value Measurements and Disclosures Topic of the FASB ASC also establishes a framework for measuring fair value and a valuation hierarchy based upon the transparency of inputs used in the valuation of an asset or liability. Classification within the hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The valuation hierarchy contains three levels: (i) valuation inputs are unadjusted quoted market prices for identical assets or liabilities in active markets (Level 1); (ii) valuation inputs are quoted prices for identical assets or liabilities in markets that are not active, quoted market prices for similar assets and liabilities in active markets, and other observable inputs directly or indirectly related to the asset or liability being measured (Level 2); and (iii) valuation inputs are unobservable and significant to the fair value measurement (Level 3).
Included in the Company’s consolidated statements of financial condition are investments in equity securities and securities sold short, both of which are exchange-traded securities with quoted prices in active markets. The fair value measurements of the equity securities, securities sold short, have been classified as Level 1. The investments in equity method investees are held at their carrying value.
The following table presents these instruments’ fair value at June 30, 2017:
Investments Not Held at Fair Value
Total Fair Value
The following table presents these instruments’ fair value at December 31, 2016:
For each of the three and six months ended June 30, 2017 and 2016, there were no transfers between levels. In addition, the Company did not hold any Level 2 or Level 3 securities during these periods.
Note 10—Property and Equipment
Property and Equipment, Net of Accumulated Depreciation is comprised of the following:
Less: Accumulated Depreciation and Amortization
Depreciation is included in general and administrative expense and totaled approximately $0.2 million and $0.5 million for the three and six months ended June 30, 2017, respectively. For the three and six months ended June 30, 2016, depreciation totaled approximately $0.3 million and $0.5 million, respectively.
Note 11—Related Party Transactions
For each of the three months ended June 30, 2017 and 2016, the Company earned $0.1 million in investment advisory fees from unconsolidated VIEs that receive investment management services from the Company. For each of the six months ended June 30, 2017 and 2016, the Company earned $0.2 million in such fees.
The Company offers loans to employees, excluding executive officers, for the purpose of financing tax obligations associated with compensatory stock and unit vesting. Loans are generally written for a seven-year period, at an interest rate equivalent to the Applicable Federal Rate, payable in annual installments, and collateralized by shares and units held by the employee. As of June 30, 2017 and December 31, 2016, the Company had approximately $1.3 million and $0.9 million, respectively, of such loans outstanding.
The operating company, as investment adviser for certain Pzena branded SEC-registered mutual funds, private placement funds, and non-U.S. funds, has contractually agreed to waive a portion or all of its management fees and pay fund expenses to ensure that the annual operating expenses of the funds stay below certain established total expense ratio thresholds. For the three and six months ended June 30, 2017, the Company recognized $0.3 million and $0.5 million of such expenses, respectively. For the three and six months ended June 30, 2016, the Company recognized $0.3 million and $0.5 million of such expenses.
The operating company manages personal funds of certain of the Company’s employees, including the CEO, its two Presidents, and its Executive Vice President. The operating company also manages accounts beneficially owned by a private fund in which certain of the Company’s executive officers invest. Investments by employees in individual accounts are permitted only at the discretion of the executive committee of the operating company, but are generally not subject to the same minimum investment levels that are required of outside investors. The operating company also manages personal funds of some of its employees’ family members. Pursuant to the respective investment management agreements, the operating company waives or reduces its regular advisory fees for these accounts and personal funds. In addition, the operating company pays custody and administrative fees for certain of these accounts and personal funds in order to incubate products or preserve performance history. The aggregate value of the fees that the Company waived related to the Company’s executive officers, other employees, and family members, was approximately $0.2 million and $0.4 million for the three and six months ended June 30, 2017, respectively. For each of the three and six months ended June 30, 2016, the Company waived $0.2 million and $0.3 million in such fees, respectively.
Note 12—Commitments and Contingencies
In the normal course of business, the Company enters into agreements that include indemnities in favor of third parties, such as engagement letters with advisers and consultants. In certain cases, the Company may have recourse against third parties with respect to these indemnities. The Company maintains insurance policies that may provide coverage against certain claims under these indemnities. The Company has had no claims or payments pursuant to these agreements, and it believes the likelihood of a claim being made is remote. Utilizing the methodology in the Guarantees Topic of the FASB ASC, the Company’s estimate of the value of such guarantees is de minimis, therefore, no accrual has been made in the consolidated financial statements.
The Company leases office space under a non-cancelable operating lease agreement, which expires on December 31, 2025. The Company recognizes minimum lease expense for its headquarters on a straight-line basis over the lease term. During the third quarter of 2016, the Company terminated its five-year sublease agreement which commenced on May 1, 2015. The Company entered into a new four-year sublease agreement commencing on October 1, 2016 that is cancelable by either the Company or sublessee given appropriate notice after the thirty-first month following the commencement of the sublease agreement. The sublease agreement is for certain office space associated with the Company's operating lease agreement in its corporate headquarters. Sublease income will continue to decrease annual lease expense by approximately $0.4 million per year.
During the three and six months ended June 30, 2017, lease expenses were $0.5 million and $1.0 million, respectively, and are included in general and administrative expense. During the three and six months ended June 30, 2016, lease expenses were $0.4 million and $0.9 million, respectively. This lease expense includes expenses associated with the Company's office spaces in the U.K. and Australia. Lease expenses for the three and six months ended June 30, 2017 were net of $0.1 million and $0.2 million of sublease income, respectively. Lease expenses for the three and six months ended June 30, 2016 were net of $0.1 million and $0.2 million of sublease income, respectively.
Note 13—Income Taxes
The operating company is a limited liability company that has elected to be treated as a partnership for tax purposes. The Company's provision for income taxes reflects U.S. federal, state, and local incomes taxes on its allocable portion of the operating company's income. The Company's effective tax rate for the six months ended June 30, 2017 and 2016 was 12.5% and 11.7%, respectively. The effective tax rate includes a rate benefit attributable to the fact that approximately 74.7% and 75.6% of the operating company's earnings were not subject to corporate-level taxes for the six months ended June 30, 2017 and 2016, 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.
The Income Taxes Topic of the FASB ASC establishes the minimum threshold for recognizing, and a system for measuring, the benefits of tax return positions in financial statements.
As of June 30, 2017 and December 31, 2016, the Company had $3.7 million and $2.8 million in unrecognized tax benefits that, if recognized, would affect the provision for income taxes. As of both June 30, 2017 and December 31, 2016, the Company had interest related to unrecognized tax benefits of $0.3 million. As of June 30, 2017 and December 31, 2016, no penalty accruals were recorded.
As of June 30, 2017 and December 31, 2016, the net values of all deferred tax assets were approximately $72.2 million and $73.4 million, respectively. These deferred tax assets primarily reflect the future tax benefits associated with the Company's initial public offering, and the subsequent and future exchanges by holders of Class B units of the operating company for shares of Class A common stock. At June 30, 2017 and December 31, 2016, the Company did not have a valuation allowance recorded against its deferred tax assets.
Note 14—Subsequent Events
On July 18, 2017, the Company declared a quarterly dividend of $0.03 per share of its Class A common stock that will be paid on August 24, 2017 to holders of record on July 28, 2017.
No other subsequent events necessitated disclosures and/or adjustments.
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 June 30, 2017, our assets under management, or AUM, was $33.5 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. As of June 30, 2017, the holders of Class A common stock (through the Company) and the holders of Class B units of our operating company held approximately 25.3% and 74.7%, respectively, of the economic interests in the operations of our business.
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.
Certain of our named executive officers and employees have interests in Pzena Investment Management, LP and certain estate planning vehicles through which they indirectly own Class B units of our operating company. As of June 30, 2017, through direct and indirect interests, our five named executive officers; 39 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 54.2%, 4.6%, and 15.9% of the economic interests in our operating company, respectively.
GAAP and Non-GAAP Net Income
GAAP diluted net income and GAAP diluted earnings per share were $10.5 million and $0.15, respectively, for the three months ended June 30, 2017, and $6.5 million and $0.09, respectively, for the three months ended June 30, 2016. GAAP diluted net income and GAAP diluted earnings per share were $19.2 million and $0.27, respectively, for the six months ended June 30, 2017, and $13.0 million and $0.19, respectively, for the six months ended June 30, 2016. Our results for the three and six months ended June 30, 2016 include 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. We believe that these accounting adjustments add a measure of non-operational complexity that partially obscures a clear understanding of the underlying performance of our business. Therefore, in evaluating our financial condition and results of operations, we also review certain non-GAAP measures of earnings, which are adjusted to exclude these items. As adjusted, non-GAAP diluted net income and non-GAAP diluted earnings per share were $6.6 million and $0.10, respectively, for the three months ended June 30, 2016. As adjusted, non-GAAP diluted net income and non-GAAP diluted earnings | {"pred_label": "__label__cc", "pred_label_prob": 0.5908348560333252, "wiki_prob": 0.4091651439666748, "source": "cc/2021-04/en_head_0005.json.gz/line1281188"} |
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