U.S. Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2003
------------------
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________ to ___________
Commission file number 000-24498
---------
DIAMOND HILL INVESTMENT GROUP, INC
----------------------------------
(Name of small business issuer in its charter)
Ohio 65-0190407
-------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
375 North Front Street, Suite 300, Columbus, Ohio 43215
-------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Issuer's telephone number (614) 255-3333
State the number of shares outstanding of each of the issuer's classes of common
equity, as of October 31, 2003:
Common Stock: 1,519,467 shares
Transitional Small Business Disclosure Format (check one): Yes [ ]; No [X]
1
DIAMOND HILL INVESTMENT GROUP, INC. AND SUBSIDIARIES
PAGE
----
Part I: FINANCIAL INFORMATION 3-22
Item 1. Financial Statements: 3-15
Consolidated Statements of Financial Condition 4
as of September 30, 2003 (unaudited)
Consolidated Statements of Operations for the 5
Nine Months and Three Months Ended September
30, 2003 and 2002 (unaudited)
Consolidated Statements of Cash Flow for the 6
Nine Months Ended September 30, 2003 and 2002
(unaudited)
Notes to the Consolidated Financial Statements 7-15
Item 2. Management's Discussion and Analysis or Plan of 16-21
Operation
Item 3. Controls and Procedures 22
Part II: OTHER INFORMATION 22-23
Item 1. Legal Proceedings 22
Item 2. Changes in Securities 22
Item 3. Defaults Upon Senior Securities 22
Item 4. Submission of Matters to a Vote of Security Holders 22
Item 5. Other Information 22
Item 6. Exhibits and Reports on Form 8-K 23
Signatures 24
Certifications for Quarterly Report on Form 10-QSB 25-26
2
DIAMOND HILL INVESTMENT GROUP, INC. AND SUBSIDIARIES
PART I FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
The accompanying consolidated financial statements, which should be read in
conjunction with the consolidated financial statements and footnotes thereto
included in the Company's Annual Report on Form 10-KSB for the year ended
December 31, 2002, are unaudited, but have been prepared in accordance with
generally accepted accounting principles for interim financial information.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments (consisting only of normal
recurring adjustments) considered necessary for a fair presentation have been
included.
Operating results for the nine months and three months ended September 30, 2003
are not necessarily indicative of the results that may be expected for the
entire fiscal year ending December 31, 2003
3
DIAMOND HILL INVESTMENT GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF FINANCIAL CONDITION
As of September 30, 2003
UNAUDITED
---------
ASSETS
Cash $ 184,607
Investment portfolio (note 3 and 4):
Mutual fund shares and limited partnership interests 2,658,801
Not readily marketable equity securities,
at estimated fair value 15,108
Accounts receivable:
Investment products 143,444
Pending settlements and other 487
Property and equipment, net of accumulated
depreciation of $126,092 137,957
Deposits and other 191,748
------------
Total assets $ 3,332,152
============
LIABILITIES
Accounts payable $ 1,244
Accrued expenses 137,513
------------
Total liabilities 138,757
------------
SHAREHOLDERS' EQUITY
Common stock: (note 5)
No par value, 7,000,000 shares authorized,
1,827,972 shares issued and 1,519,467 shares outstanding 10,024,999
Treasury stock, at cost (308,505 shares) (1,765,136)
Deferred compensation (5,757)
Accumulated deficit (5,060,711)
------------
Total shareholders' equity 3,193,395
------------
Total liabilities and shareholders' equity $ 3,332,152
============
The accompanying notes are an integral part of these consolidated financial
statements.
4
DIAMOND HILL INVESTMENT GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Nine Months and Three Months Ended
September 30, 2003 and September 30, 2002
UNAUDITED
---------
9 MONTHS ENDED 3 MONTHS ENDED
-------------- --------------
SEP 2003 SEP 2002 SEP 2003 SEP 2002
------------ ------------ ------------ ------------
INVESTMENT MANAGEMENT FEES:
Mutual funds $ 312,095 $ 268,949 $ 122,534 $ 79,481
Managed accounts 403,015 194,542 149,724 74,182
Private partnership 41,566 15,814 16,759 9,852
------------ ------------ ------------ ------------
Total investment management fees 756,676 479,305 289,017 163,515
OPERATING EXPENSES:
Salaries, benefits and payroll taxes 1,148,883 1,131,470 380,584 381,194
Legal and audit 52,638 157,703 13,002 56,887
General and administrative 347,348 387,511 129,279 180,937
Sales and marketing 118,860 164,876 36,311 73,469
------------ ------------ ------------ ------------
Total operating expenses 1,667,729 1,841,560 559,176 692,487
------------ ------------ ------------ ------------
Mutual fund administration, net (Note 7) (201,486) (240,526) (40,826) (105,964)
Mutual fund distribution, net (Note 8) (68,278) (41,310) (12,639) 24,521
Broker-dealer activity, net (Note 9) (13,096) (135,703) 174 (62,682)
------------ ------------ ------------ ------------
NET OPERATING INCOME (LOSS) (1,193,913) (1,779,794) (323,450) (673,097)
------------ ------------ ------------ ------------
Investment return, net of interest expense 244,319 (277,017) 59,038 (478,311)
------------ ------------ ------------ ------------
INCOME (LOSS) BEFORE TAXES (949,594) (2,056,811) (264,412) (1,151,408)
------------ ------------ ------------ ------------
Income Tax Provision (Credit) -- -- -- --
------------ ------------ ------------ ------------
NET INCOME (LOSS) $ (949,594) $ (2,056,811) $ (264,412) $ (1,151,408)
============ ============ ============ ============
Basic Earnings (Loss) Per Share $ (0.66) $ (1.44) $ (0.18) $ (0.82)
============ ============ ============ ============
Diluted Earnings (Loss) Per Share $ (0.66) $ (1.44) $ (0.18) $ (0.82)
============ ============ ============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
5
DIAMOND HILL INVESTMENT GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Nine Months Ended September 30, 2003 and 2002
UNAUDITED
---------
2003 2002
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (949,594) $ (2,056,811)
Adjustments to reconcile net income (loss)
to net cash provided by (used in) operating activities:
Depreciation and amortization 28,767 43,352
Loss on disposal of property and equipment 732 39,766
Amortization of deferred compensation 9,417 17,351
Unrealized (gain) loss (263,994) 443,280
(Increase) decrease in certain assets:
Investment portfolio 380,568 474,253
Accounts receivable:
Investment products (53,585) (7,794)
Pending settlements and other (369) (3,553)
Refundable income taxes -- 414,251
Deposits and other (33,060) (52,574)
Increase (decrease) in certain liabilities-
Accounts payable to broker-dealers and other 1,244 6,632
Accrued expenses and other (121,297) (163,185)
------------ ------------
Net cash used in operating activities (1,001,171) (845,032)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (2,307) (123,826)
Proceeds from sale of property and equipment -- --
------------ ------------
Net cash used in investing activities (2,307) (123,826)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Exercise of stock options 3,910 --
Purchase of treasury stock -- (292,700)
Sale of treasury stock 495,000 --
Note payable - line of credit -- 152,200
------------ ------------
Net cash provided by (used in) financing activities 498,910 (140,500)
------------ ------------
NET DECREASE IN CASH (504,568) (1,109,358)
CASH, BEGINNING OF PERIOD 689,175 1,174,026
------------ ------------
CASH, END OF PERIOD $ 184,607 $ 64,668
============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest $ 693 $ 493
Income taxes -- --
The accompanying notes are an integral part of these consolidated financial
statements.
6
DIAMOND HILL INVESTMENT GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2003
Note 1 ORGANIZATION AND NATURE OF BUSINESS
-----------------------------------
Diamond Hill Investment Group, Inc. (the Company) is an Ohio corporation
incorporated in May 2002, previously a Florida corporation since April 1990. The
Company has two subsidiary operating companies.
Diamond Hill Capital Management, Inc. (DHCM), an Ohio corporation, is a wholly
owned subsidiary of the Company and a registered investment advisor. DHCM is the
investment adviser to the Diamond Hill Focus Fund, Diamond Hill Small Cap Fund,
Diamond Hill Large Cap Fund, Diamond Hill Short Term Fixed Income Fund and
Diamond Hill Strategic Income Fund, open-end mutual funds, which are each a
series in the Diamond Hill Funds trust. DHCM is also the investment adviser to
the Diamond Hill Investment Partners, L.P. and offers advisory services to
institutional and individual investors.
Diamond Hill Securities, Inc. (DHS), an Ohio corporation, is a wholly owned
subsidiary of DHCM and a NASD registered broker-dealer. DHS is registered with
the Securities and Exchange Commission and the securities commissions of six
states (including Ohio). DHS trades securities on a fully-disclosed basis and
clears customer transactions through an unaffiliated broker-dealer that also
maintains the customer accounts. DHS is also a registered investment adviser and
offers advisory services to institutional and individual investors. DHS is the
investment adviser to the Diamond Hill Bank & Financial Fund, which is a series
in the Diamond Hill Funds trust.
Note 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
------------------------------------------
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and the reported amounts
of revenues and expenses for the periods. Actual results could differ from those
estimates. The following is a summary of the Company's significant accounting
policies:
Principles of Consolidation
---------------------------
The accompanying consolidated financial statements include the operations of the
Company, DHCM and DHS. All material inter-company transactions and balances have
been eliminated in consolidation.
Cash
----
The Company has defined cash as demand deposits, certificate of deposits and
money market accounts. The Company maintains its cash in seven accounts with two
financial institutions.
Accounts Receivable
-------------------
Accounts receivable are recorded when they are due and are presented in the
statement of financial condition net of any allowance for doubtful accounts.
Accounts receivable are written off when they are determined to be
uncollectible. Any allowance for doubtful accounts is estimated on the Company's
historical losses, existing conditions in the industry, and the financial
stability of those individuals that owe the receivable. No allowance for
doubtful accounts was deemed necessary at September 30, 2003.
Valuation of Investment Portfolio
---------------------------------
Securities and related options traded on national securities markets and
securities not traded on national securities markets, but with readily
ascertainable market values, are valued at market value. Other securities, for
which market quotations are not readily available, due to infrequency of
transactions, are valued at fair value as determined in good faith by the
management of the Company. Realized and unrealized gains and losses are included
in investment profits and losses.
7
DIAMOND HILL INVESTMENT GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2003
Note 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
------------------------------------------
Limited Partnership Interests
-----------------------------
DHCM is the managing member of Diamond Hill General Partner, LLC, the General
Partner of Diamond Hill Investment Partners, L.P. (DHIP), a limited partnership
whose underlying assets consist of marketable securities. DHCM's investment in
DHIP is accounted for using the equity method, under which DHCM's share of the
net earnings or losses of the partnership is reflected in income as earned and
distributions received are reflected as reductions of the investment. The
Company is actively seeking additional unaffiliated investors for DHIP. Several
board members, officers and employees of the Company are members in Diamond Hill
General Partner, LLC. The capital of Diamond Hill General Partner, LLC is not
subject to a management fee or an incentive fee.
Property and Equipment
----------------------
Property and equipment, consisting of computer equipment, furniture, and
fixtures, is carried at cost less accumulated depreciation. Depreciation is
calculated using the straight-line method over estimated lives of five to seven
years.
Reclassifications
-----------------
The consolidated statement of operations for the nine months and three months
ended September 30, 2002, has been reclassified to conform to the presentation
of the consolidated statement of operations for the nine months and three months
ended September 30, 2003. These reclassifications have had no effect on the
operating results for the nine months and three months ended September 30, 2002.
Revenues
--------
Securities transactions and commissions are accounted for on the trade date
basis. Dividend income is recorded on the ex-dividend date and interest income
is accrued as earned. Realized gains and losses from sales of securities are
determined utilizing the first-in, first-out method (FIFO).
Earnings Per Share
------------------
Basic and diluted earnings per common share are computed in accordance with
Statement of Financial Accounting Standards No. 128, "Earnings per Share." A
reconciliation of the numerators and denominators used in these calculations is
shown below:
For the nine months ended September 30, 2003:
Numerator Denominator Amount
------------ ------------ ------------
Basic Earnings $ (949,594) 1,437,231 $ (0.66)
Diluted Earnings $ (949,594) 1,437,231 $ (0.66)
For the nine months ended September 30, 2002:
Numerator Denominator Amount
------------ ------------ ------------
Basic Earnings $ (2,056,811) 1,430,040 $ (1.44)
Diluted Earnings $ (2,056,811) 1,430,040 $ (1.44)
8
DIAMOND HILL INVESTMENT GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2003
Note 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
------------------------------------------
Earnings Per Share (Continued)
------------------
For the three months ended September 30, 2003:
Numerator Denominator Amount
------------ ------------ ------------
Basic Earnings $ (264,412) 1,491,967 $ (0.18)
Diluted Earnings $ (264,412) 1,491,967 $ (0.18)
For the three months ended September 30, 2002:
Numerator Denominator Amount
------------ ------------ ------------
Basic Earnings $ (1,151,408) 1,412,542 $ (0.82)
Diluted Earnings $ (1,151,408) 1,412,542 $ (0.82)
Stock options and warrants have not been included in the denominator of the
diluted per-share computations because the effect of their inclusion would be
anti-dilutive.
Fair Value of Financial Instruments
-----------------------------------
Substantially all of the Company's financial instruments are carried at fair
value or amounts approximating fair value. Assets, including accounts
receivable, notes and interest receivable and securities owned are carried at
amounts that approximate fair value. Similarly, liabilities, including accounts
payable and accrued expenses are carried at amounts approximating fair value.
Note 3 INVESTMENT PORTFOLIO
--------------------
Investment portfolio balances, which consist of securities classified as
trading, are comprised of the following at September 30, 2003:
Unrealized Unrealized
Market Cost Gains Losses
------------ ------------ ------------ ------------
Mutual fund shares and
limited partnership interest $ 2,658,801 $ 2,364,609 $ 294,626 $ (434)
Not readily marketable
equity securities 15,108 200,150 -- (185,042)
------------ ------------ ------------ ------------
Total $ 2,673,909 $ 2,564,759 $ 294,626 $ (185,476)
============ ============ ============ ============
DHCM is the managing member of the General Partner of Diamond Hill Investment
Partners, L.P., whose underlying assets consist primarily of marketable
securities. The General Partner is contingently liable for all of the
partnership's liabilities.
9
DIAMOND HILL INVESTMENT GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2003
Note 3 INVESTMENT PORTFOLIO (Continued)
--------------------
Summary financial information, including the Company's carrying value and income
from this partnership at September 30, 2003 and 2002 and for the nine months
then ended, is as follows:
2003 2002
------------ ------------
Total assets $ 19,131,239 $ 11,211,502
Total liabilities 7,621,422 3,361,068
Net assets 11,509,817 7,850,434
Net fair market value of earnings 1,032,734 (732,970)
DHCM's carrying value 1,223,581 2,886,126
DHCM's income 113,873 (178,310)
DHCM's income from this partnership includes its pro-rata capital allocation and
its share of an incentive allocation from the limited partners. In addition,
DHCM earns an administrative fee payable quarterly at the rate of .25% of the
value of the limited partners' capital accounts.
Note 4 LINE OF CREDIT
--------------
The Company renewed its line of credit loan with a maximum principal amount of
$325,000 on August 28, 2003 at an annual percentage interest rate of prime plus
0.50%, which is currently 4.50%. The balance due on the line of credit loan at
September 30, 2003 was zero ($0). The Company has pledged $390,000 of its fixed
income mutual fund investments to secure this line. The line of credit loan is
due to mature on August 28, 2004, at which time management intends to renew the
line.
Note 5 CAPITAL STOCK
-------------
Common Stock
------------
The Company has only one class of securities, Common Stock.
Treasury Stock
--------------
On July 17, 2000, the Company announced a program to repurchase up to 400,000
shares of its Common Stock through open market purchases and privately
negotiated transactions. From July 17, 2000 through December 31, 2001, the
Company purchased 281,597 shares of its Common Stock for $1,716,407. For the
nine months and three months ended September 30, 2002, the Company purchased
71,300 shares and 15,000 shares of its Common Stock for $292,700 and $67,500,
respectively. For the nine months and three months ended September 30, 2003, the
Company did not purchase any of its shares of Common Stock. As of September 30,
2003, the Company has purchased 352,897 shares for $2,009,107 pursuant to the
aforementioned 400,000 share repurchase program. On July 22, 2003, the Company
issued 110,000 shares out of Treasury Stock in a private placement to certain
directors, officers and employees of the Company. The shares were sold at $4.50
per share, and Treasury Stock was reduced by an average cost of $5.72 per share.
The Company's total Treasury Stock share balance as of September 30, 2003 is
308,505.
Authorization of Preferred Stock
--------------------------------
The Company's Articles of Incorporation authorize the issuance of 1,000,000
shares of "blank check" preferred stock with such designations, rights and
preferences, as may be determined from time to time by the Company's Board of
Directors. The Board of Directors is empowered, without shareholder approval, to
issue preferred stock with dividend, liquidation, conversion, voting, or other
rights, which could adversely affect the voting or other rights of the holders
of the Common Stock. There were no shares of preferred stock issued or
outstanding at September 30, 2003.
10
DIAMOND HILL INVESTMENT GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2003
Note 6 OPERATING LEASES
----------------
The Company leases office space under an operating lease agreement effective May
1, 2002, which terminates on May 31, 2005. Total lease expenses for the nine
months and three months ended September 30, 2003 were $90,000 and $30,000,
respectively. The future minimum lease payments under the operating lease are as
follows:
Year Ended Amount
-------------- ----------
2003 120,000
2004 120,000
2005 50,000
Note 7 MUTUAL FUND ADMINISTRATION
--------------------------
DHCM has an administrative, fund accounting and transfer agency services
agreement with Diamond Hill Funds, an Ohio business trust, under which DHCM
performs certain services for each series of the trust. These services include
mutual fund administration, accounting, transfer agency and other related
functions. For performing these services, each series of the trust compensates
DHCM a fee at an annual rate of 0.45% times each series' average daily net
assets. DHCM collected $174,481 and $144,701 for mutual fund administration
revenue for the nine months ended September 30, 2003 and 2002, respectively; and
for the three months ended September 30, 2003 and 2002, DHCM collected $72,540
and $54,793 for administration revenue, respectively. In fulfilling its role
under this agreement, DHCM has engaged several third-party providers, and the
cost for their services are paid by DHCM. Mutual fund administration expense for
the nine months ended September 30, 2003 and 2002 was $375,967 and $385,227,
respectively, and for the three months ended September 30, 2003 and 2002 was
$113,366 and $160,757, respectively.
Note 8 MUTUAL FUND DISTRIBUTION
------------------------
DHS is the principal underwriter for Diamond Hill Funds, an Ohio business trust,
and may pay third-party financial institutions a fee for distribution or for
performing certain servicing functions for mutual fund shareholders. For
performing distribution functions, DHS collects front-end and back-end sales
loads, ranging from 1.00% to 5.75% or underwriting fees of 0.50% on fund
investments. DHS also collects 12b-1 fees at an annual rate ranging from 0.25%
to 1.00% times each series' average daily net assets. Mutual fund distribution
revenue for the nine months ended September 30, 2003 and 2002 was $104,404 and
$84,002, respectively; and for the three months ended September 30, 2003 and
2002, DHS collected $42,097 and $29,463 for distribution revenue. DHS also pays
for the production of marketing materials used in the distribution of the
Diamond Hill Funds. Mutual fund distribution expense for the nine months ended
September 30, 2003 and 2002 was $172,682 and $125,312, respectively, and for the
three months ended September 30, 2003 and 2002 was $54,736 and $4,942,
respectively.
Note 9 BROKER-DEALER ACTIVITY
----------------------
DHS is a registered full-service broker-dealer transacting security trades
through its clearing broker under a correspondent agreement. For the nine months
ended September 30, 2003 and 2002, broker-dealer activity expenses, principally
clearing charges and regulatory fees, totaled $36,753 and $150,158,
respectively, and for the three months ended September 30, 2003 and 2002 totaled
$4,148 and $43,250, respectively. DHS earns commissions and service fees related
to business transacted through its clearing broker, along with gains and losses
from market-making activities. Broker-dealer activity revenue for the nine
months ended September 30, 2003 and 2002 was $23,657 and $14,455, respectively.
For the three months ended September 30, 2003 and 2002, broker-dealer activity
generated $4,322 in revenue and lost $19,432, respectively. This revenue loss in
the third quarter of 2002 was the result of $27,977 in market making losses.
11
DIAMOND HILL INVESTMENT GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2003
Note 10 EMPLOYEE INCENTIVE PLANS
------------------------
Incentive Compensation Plan
---------------------------
All full-time employees of the Company are eligible to participate in the
Diamond Hill Investment Group Incentive Compensation Plan. The Plan provides
that a bonus fund will be established in an amount equal to 20% of the pre-tax
realized profits of the Company in excess of a 15% pre-tax return on equity. The
amount of the bonus fund is calculated each fiscal quarter on a cumulative
basis. The allocation of the bonus fund is to be made by the President of the
Company. The Company did not incur any expense under the Plan for the three
months and nine months ended September 30, 2003 and 2002.
Stock Option Plan
-----------------
The Company has a Non-Qualified and Incentive Stock Option Plan that authorizes
the grant of options to purchase an aggregate of 500,000 shares of the Company's
Common Stock. The Plan provides that the Board of Directors, or a committee
appointed by the Board, may grant options and otherwise administer the Option
Plan. The exercise price of each incentive stock option or non-qualified stock
option must be at least 100% of the fair market value of the Common Stock at the
date of grant, and no such option may be exercisable for more than ten years
after the date of grant. However, the exercise price of each incentive stock
option granted to any shareholder possessing more than 10% of the combined
voting power of all classes of capital stock of the Company on the date of grant
must not be less than 110% of the fair market value on that date, and no such
option may be exercisable more than five years after the date of grant.
During the three months ended September 30, 2003, there were no options to
purchase shares of Common Stock issued.
The Company applies Accounting Principles Board Opinion 25 and related
Interpretations (APB 25) in accounting for stock options and warrants issued to
employees and Directors. Accordingly, compensation cost is recognized based on
the intrinsic value of the stock options or warrants.
Had compensation cost for all of the Company's stock-based awards been
determined in accordance with FAS 123, the Company's net income and earnings per
share would have been reduced to the pro forma amounts indicated below:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
------------------------ ------------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
Net income, as reported (264,412) (1,151,408) (949,594) (2,056,811)
Deduct: Total stock-based employee
compensation expense determined
under fair value based method for
all awards, net of related tax effects (40,976) (75,235) (171,648) (356,467)
Pro forma net income (305,388) (1,226,643) (1,121,242) (2,413,278)
Earnings per share:
Basic - as reported (0.18) (0.82) (0.66) (1.44)
Basic - pro forma (0.20) (0.87) (0.78) (1.69)
Diluted - as reported (0.18) (0.82) (0.66) (1.44)
Diluted - pro forma (0.20) (0.87) (0.78) (1.69)
12
DIAMOND HILL INVESTMENT GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2003
Note 10 EMPLOYEE INCENTIVE PLANS (Continued)
------------------------
Stock Option Plan (Continued)
-----------------
To make the computations of pro forma results under FAS 123, the fair value of
each option grant is estimated on the date of grant using the Black-Scholes
option-pricing model with the following weighted-average assumptions: no
dividend yield for all years and expected lives of ten years. The options and
warrants granted under these plans are not registered and, accordingly, there is
no quoted market price.
A summary of the status of the Company's stock option and warrants plans as of
September 30, 2003 and September 30, 2002 and changes during the nine months
ending on those dates is presented below:
Options Warrants
--------------------- ---------------------
Exercise Exercise
Shares Price Shares Price
--------- --------- --------- ---------
Outstanding December 31, 2001 186,902 $ 17.245 280,400 $ 12.895
Granted -- -- -- --
Expired unexercised (10,700) 23.601 -- --
Forfeited (10,300) 12.419 -- --
--------- ---------
Outstanding September 30, 2002 165,902 17.124 280,400 12.895
========= =========
Exercisable September 30, 2002 97,742 $ 21.395 200,400 $ 14.852
========= =========
Outstanding December 31, 2002 165,902 $ 17.124 280,400 $ 12.895
Granted 120,000 4.500 -- --
Exercised 1,000 3.910 -- --
Expired unexercised (11,510) 28.983 -- --
Forfeited (25,190) 15.468 (40,000) 8.000
--------- ---------
Outstanding September 30, 2003 248,202 10.693 240,400 13.712
========= =========
Exercisable September 30, 2003 114,202 $ 17.624 240,400 $ 13.712
========= =========
13
DIAMOND HILL INVESTMENT GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2003
Note 10 EMPLOYEE INCENTIVE PLANS (Continued)
------------------------
Stock Option Plan (Continued)
-----------------
The following table summarizes information about fixed stock options and
warrants outstanding at September 30, 2003:
Options Warrants
---------- ----------
Range of exercise prices $ 73.750 $ 73.750
Number outstanding 16,202 14,000
Weighted-average remaining
Contractual life in years 4.609 4.609
Weighted-average exercise price $ 73.750 $ 73.750
Number exercisable 16,202 14,000
Range of exercise prices $ 7.95 - $ 14.375 $ 22.20 - $ 22.50
Number outstanding 46,000 16,400
Weighted-average remaining
Contractual life in years 3.632 5.611
Weighted-average exercise price $ 12.029 $ 22.495
Number exercisable 44,000 16,400
Range of exercise prices $ 5.25 - $ 8.45 $ 8.00 - $ 14.375
Number outstanding 66,000 210,000
Weighted-average remaining
Contractual life in years 7.740 5.942
Weighted-average exercise price $ 5.541 $ 9.024
Number exercisable 34,000 210,000
Range of exercise prices $ 4.50
Number outstanding 120,000
Weighted-average remaining
Contractual life in years 9.667
Weighted-average exercise price $ 4.500
Number exercisable 20,000
14
DIAMOND HILL INVESTMENT GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2003
Note 11 REGULATORY REQUIREMENTS
-----------------------
DHS is subject to the uniform net capital rule of the Securities and Exchange
Commission (Rule 15c3-1), which requires that the ratio of "aggregate
indebtedness" to "net capital" not exceed 15 to 1 (as those terms are defined by
the Rule). DHS had net capital of $194,691 as of September 30, 2003, which was
in excess of its required minimum net capital of $50,000. The ratio of aggregate
indebtedness to net capital was .12 to 1 as of September 30, 2003. DHS is also
subject to regulations of six states in which it is registered as a licensed
broker-dealer.
DHCM and DHS are registered investment advisers and subject to regulation by the
SEC pursuant to the Investment Advisors Act of 1940.
Note 12 CONCENTRATIONS OF CREDIT RISK AND FINANCIAL INSTRUMENTS WITH
----------------------------------------------------------------------
OFF-BALANCE SHEET RISK
----------------------
DHS, under a correspondent agreement with its clearing broker, has agreed to
indemnify the clearing broker from damages or losses resulting from customer
transactions. The Company is, therefore, exposed to off-balance sheet risk of
loss in the event that customers are unable to fulfill contractual obligations.
The Company manages this risk by requiring customers to have sufficient cash in
their account before a buy order is executed and to have the subject securities
in their account before a sell order is executed. The Company has not incurred
any losses from customers unable to fulfill contractual obligations.
In the normal course of business, the Company periodically sells securities not
yet purchased (short sales) for its own account and writes options. The
establishment of short positions and option contracts exposes the Company to
off-balance sheet market risks in the event prices change, as the Company may be
obligated to cover such positions at a loss. At September 30, 2003, the Company
had no short security positions, had not written any option contracts and did
not own any options. The Company did not experience any credit losses due to the
failure of any counterparties to perform during the nine months ended September
30, 2003. Senior management of the Company is responsible for reviewing trading
positions, exposures, profits and losses, trading strategies and hedging
strategies on a daily basis.
15
DIAMOND HILL INVESTMENT GROUP, INC. AND SUBSIDIARIES
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Forward-looking Statements
--------------------------
Throughout this discussion, the Company may make forward-looking statements
relating to such matters as anticipated operating results, prospects for
achieving the critical threshold of assets under management, technological
developments, economic trends (including interest rates and market volatility),
expected transactions and acquisitions and similar matters. While the Company
believes that the assumptions underlying its forward-looking statements are
reasonable, any of the assumptions could prove to be inaccurate and accordingly,
the actual results and experiences of the Company could differ materially from
the anticipated results or other expectations expressed by the Company in its
forward-looking statements. Factors that could cause such actual results or
experiences to differ from results discussed in the forward-looking statements
include, but are not limited to: the adverse effect from a decline in the
securities markets; a decline in the performance of the Company's products; a
general downturn in the economy; changes in government policy and regulation;
changes in the Company's ability to attract or retain key employees; unforeseen
costs and other effects related to legal proceedings or investigations of
governmental and self-regulatory organizations; and other risks identified from
time-to-time in the Company's other public documents on file with the SEC.
General
-------
With the change in executive management in May of 2000, the Company shifted its
emphasis from its traditional investment related activities through its DHS
subsidiary, to the investment advisory services of its DHCM subsidiary. DHCM
manages portfolios of stocks representing interests in entities operating in
various economic sectors, as opposed to a portfolio of bank stocks only.
Staffing and costs associated with this shift and the various marketing
initiatives at DHCM negatively impacted the Company in 2002 and may continue in
2003. Management believes that this process was necessary in order to achieve a
critical threshold of assets under management to support operations in the
future. However, there can be no assurance that the Company will be able to
achieve the critical threshold of assets under management to support future
operations.
Assets Under Management
-----------------------
As of September 30, 2003, assets under management totaled $198.3 million, an 80%
increase from December 31, 2002. Assets under management grew by 126% as of
September 30, 2003 in comparison to September 30, 2002. Asset growth for the
nine months and year ended September 30, 2003 is not necessarily indicative of
the results that may be expected for the entire fiscal year ended December 31,
2003. The table below provides a summary of assets under management:
9/30/2003 12/31/2002 9/30/2002
------------ ------------ ------------
Separately Managed Accounts $117,432,649 $ 58,297,957 $ 41,896,773
Mutual Funds 69,360,502 44,819,496 37,825,428
Alternative Investment 11,513,417 7,210,934 7,850,434
------------ ------------ ------------
Total Assets Under Management $198,306,568 $110,328,387 $ 87,572,635
Three months ended September 30, 2003 compared to Three Months ended September
--------------------------------------------------------------------------------
30, 2002
--------
Investment management revenues for the three months ended September 30, 2003
increased to $289,017 compared to $163,515 for the three months ended September
30, 2002, a 77% increase. This increase results primarily from the increase in
assets under management from which the Company derives its revenues.
The Company increased its investment management fees from all three of its
investment products - mutual funds, managed accounts and a private investment
partnership, Diamond Hill Investment Partners, L.P. ("DHIP"). Fees from mutual
funds for the three months ended September 30, 2003 and 2002, were $122,534 and
$79,481, respectively, a 54% increase. Fees from managed accounts posted the
largest dollar increase over the three months ended September 30, 2002, with a
dollar increase of $75,542, or a 102% increase.
16
DIAMOND HILL INVESTMENT GROUP, INC. AND SUBSIDIARIES
Investment management fees collected from the DHIP improved by 70%, over the
three months ended September 30, 2002. These fees grew from $9,852 to $16,759.
In conjunction with the shift in emphasis to the investment advisory services of
DHCM, a program has been initiated to attempt to gather new assets under
management at DHCM. Assets under management increased to $198,306,568 as of
September 30, 2003, a 20% increase since June 30, 2003. However, there can be no
assurance that the Company will be able to achieve the critical threshold of
assets under management at DHCM to support future operations.
Operating expenses for the three months ended September 30, 2003 decreased to
$559,176 compared to $692,487 for the three months ended September 30, 2002, a
decrease of 19%. Salaries, benefits and payroll taxes were essentially flat at
$380,584 in 2003 versus $381,194 in 2002. Legal and audit expense dropped to
$13,002 from $56,887 for the three months ended September 30, 2003 versus the
three months ended September 30, 2002, a 77% decrease. Since there are no
current plans for major administrative projects or new products, management
expects legal and audit professional expense to drop in 2003 as compared to
2002. General and administrative expenses decreased to $129,279 in 2003 compared
to $180,937 in 2002, a decrease of 29%, primarily due to the $39,766 fixed asset
write-off during the three months ended September 30, 2002. Sales and marketing
expense for the three months ended September 30, 2003 decreased by 51% to
$36,311 from $73,469 for the three months ended September 30, 2002. This
decrease is due to the reduced expenditures for consulting services.
Mutual fund administration, which is administrative services fees collected in
connection with the Company's mutual fund products net of all mutual fund
administrative expenses paid by the Company, decreased from a net expense of
$105,964 for the three months ended September 30, 2002 to $40,826 for the three
months ended September 30, 2003, a 61% improvement. Administrative fees
collected increased, while expenses paid decreased for the three months ended
September 30, 2003 versus the three months ended September 30, 2002. This
increase in fees is primarily due to the increase in assets under management in
the Company's mutual fund products. The decrease in expenses is primarily due to
the decrease in legal fees from $60,646 to $3,325 for the three months ended
September 30, 2002 and 2003, respectively. Legal fees were higher in 2002
because of new product start-up costs. DHCM has an administrative, fund
accounting and transfer agency services agreement with the Diamond Hill Funds,
where DHCM performs certain services for each series of the trust. These
services include mutual fund administration, accounting, transfer agency and
other related functions. For performing these administrative services, each
series of the trust compensates DHCM a fee at an annual rate of 0.45% times each
series' average daily net assets. DHCM collected $72,540 and $54,793 for mutual
fund administration revenue for the three months ended September 30, 2003 and
2002, respectively. In fulfilling its role under this agreement, DHCM has
engaged several third-party providers and the cost for their services are paid
by DHCM. Mutual fund administration expense for the three months ended September
30, 2003 and 2002 were $113,366 and $160,757, respectively. As assets under
management grow in the mutual fund products, the Company expects fees collected
to increase, while the Company expects expenses paid to remain relatively
steady; therefore, causing the net mutual fund administration expense to
decrease.
Mutual fund distribution, which includes distribution fees collected in
connection with sales of the Company's mutual funds net of all mutual fund
distribution expenses paid by the Company, increased to a net expense of $12,639
for the three months ended September 30, 2003 from a net revenue of $24,521 for
the three months ended September 30, 2002. Mutual fund distribution fees and
expenses both increased during the three months ended September 30, 2003 versus
the three months ended September 30, 2002. For performing these distribution
functions, DHS collects front-end and back-end sales loads, ranging from 1.00%
to 5.75% or underwriting fees of 0.50% on fund investments. DHS also collects
12b-1 fees at an annual rate ranging from 0.25% to 1.00% times each series'
average daily net assets. Mutual fund distribution revenue for the three months
ended September 30, 2003 and 2002 was $42,097 and $29,463, respectively. This
increase in fees is primarily due to the increase in assets under management in
the Company's mutual fund products. DHS is the principal underwriter for Diamond
Hill Funds, an Ohio business trust, and may pay third-party financial
institutions a fee for distribution or for performing certain servicing
functions for mutual fund shareholders. DHS also pays for the production of
marketing materials used in the distribution of the Diamond Hill Funds. Mutual
fund distribution expense for the three months ended September 30, 2003 and 2002
was $54,736 and $4,942, respectively. This increase is the result of increased
sales of the mutual fund
17
DIAMOND HILL INVESTMENT GROUP, INC. AND SUBSIDIARIES
shares in 2003 versus 2002, in which DHS finances the commissions paid, and
decreased expense in 2002 due to an adjustment made, during the three months
ended September 30, 2002, for a change in accounting treatment for commissions
paid to brokers for the sale of the Company's mutual fund C shares. Previously,
the commission was expensed when paid, despite the fact that the revenue, which
offsets this expense, is collected over a twelve-month period. Therefore, the
portion of commission expense that has not yet been offset by the matching
revenue was capitalized and amortized over twelve months. As assets under
management grow in the mutual fund products, the Company expects fees collected
to increase, while the Company expects expenses paid to remain steady or
increase; therefore, causing the net mutual fund distribution expense to
decrease.
Broker-dealer activity, which is revenue from security transactions and
market-making activity net of broker-dealer expenses which are comprised
principally of clearing costs and regulatory fees, decreased to a net revenue of
$174 for the three months ended September 30, 2003 from a net expense of $62,682
for the three months ended September 30, 2002, a 100% improvement. DHS is a
registered full-service broker-dealer and transacts security trades through its
clearing broker under a correspondent agreement. For the three months ended
September 30, 2003 and 2002, broker-dealer activity expenses were $4,148 and
$43,250, respectively. This decrease is largely due to the reduction in overhead
and commission expense from reduced activity. DHS earns commissions and service
fees related to business transacted through its clearing broker, along with
gains and losses from market-making activities. Broker-dealer activity generated
revenue of $4,322 for the three months ended September 30, 2003 and lost $19,432
for the three months ended September 30, 2002. This revenue loss in the third
quarter of 2002 was the result of $27,977 in market making losses. In
conjunction with the Company's shift in emphasis from its traditional investment
related activities through DHS, to the investment advisory services of DHCM,
broker dealer activities through DHS have declined. It is expected for 2003,
that this level of expense in 2002 will decrease.
The Company's net operating loss decreased to $323,450 for the three months
ended September 30, 2003 from $673,097 for the three months ended September 30,
2002, a 52% improvement.
Investment return, net of interest expense, increased to a gain of $59,038 for
the three months ended September 30, 2003 from a loss of $478,311 for the three
months ended September 30, 2002, a 112% increase. This investment gain results
primarily from increases in market values of investments in the limited
partnership interest and the Company's mutual funds. Management is unable to
predict how future fluctuations in market values will impact the performance of
the Company's investment portfolios. Dividend income increased by a multiple of
4.5 to $18,623 for the three months ended September 30, 2003 compared to $4,102
for the three months ended September 30, 2002. In 2003, dividend income may
increase versus 2002 since the Company reallocated approximately $1.5 million of
its investments from DHIP to the Company's fixed income mutual funds, which pay
monthly dividends, yielding an anticipated average of five percent (5%). The
Company reduced its equity market exposure, due to the potential large swing in
the market value of its portfolio investments. As a result, of this change and
better market returns in 2003 versus 2002, the Company's net loss decreased by
77% for the three months ended September 30, 2003 compared to the same time
period for 2002.
Nine Months ended September 30, 2003 compared to Nine Months ended September 30,
--------------------------------------------------------------------------------
2002
----
Investment management revenues for the nine months ended September 30, 2003
increased to $756,676 compared to $479,305 for the nine months ended September
30, 2002, a 58% increase. This increase results primarily from the increase in
assets under management from which the Company derives its revenues.
The Company increased its investment management fees from all three of its
investment products: mutual funds, managed accounts and a private investment
partnership, Diamond Hill Investment Partners, L.P. ("DHIP"). Fees from mutual
funds were up 16%, for the nine months ended September 30, 2003, from $268,949
to $312,095. Fees from managed accounts posted the largest dollar increase over
the nine months ended September 30, 2002, with at dollar increase of $208,473,
or a 107% increase. Investment management fees collected from the DHIP improved
the most, relatively, over the nine months ended September 30, 2002. These fees
grew by a multiple of 2.6, increasing from $15,814 to $41,566. In
18
DIAMOND HILL INVESTMENT GROUP, INC. AND SUBSIDIARIES
conjunction with the shift in emphasis to the investment advisory services of
DHCM, a program has been initiated to attempt to gather new assets under
management at DHCM. Assets under management increased to $198,306,568 as of
September 30, 2003, an 80% increase since December 31, 2002. However, there can
be no assurance that the Company will be able to achieve the critical threshold
of assets under management at DHCM to support future operations.
Operating expenses for the nine months ended September 30, 2003 decreased to
$1,667,729 compared to $1,841,560 for the nine months ended September 30, 2002,
a decrease of 9%. Salaries, benefits and payroll taxes increased slightly to
$1,148,883 in 2003 from $1,131,470 in 2002, an increase of 2%. This increase
reflects personnel changes. Legal and audit expense dropped to $52,638 from
$157,703 for the nine months ended September 30, 2003 versus the nine months
ended September 30, 2002, a 67% decrease. Since there are no current plans for
major administrative projects or new products, management expects legal and
audit professional expense to drop in 2003 as compared to 2002. General and
administrative expenses decreased to $347,348 in 2003 compared to $387,511 in
2002, a decrease of 10%. This decrease is primarily due to a $39,766 fixed asset
write-off during the nine months ended September 30, 2002. Sales and marketing
expense for the nine months ended September 30, 2003 decreased by 28% to
$118,860 from $164,876 for the nine months ended September 30, 2002. This
decrease is primarily due the reduction in expenditures for consulting services.
Mutual fund administration, which is administrative services fees collected in
connection with the Company's mutual fund products net of all mutual fund
administrative expenses paid by the Company, decreased from a net expense of
$240,526 for the nine months ended September 30, 2002 to $201,486 for the nine
months ended September 30, 2003, a 16% improvement. Administrative fees
collected increased, while administrative expenses paid decreased slightly for
the nine months ended September 30, 2003 versus the nine months ended September
30, 2002. This increase in fees is primarily due to the increase in assets under
management in the Company's mutual fund products. The decrease in expenses is
primarily due to the decrease in legal fees. DHCM has an administrative, fund
accounting and transfer agency services agreement with the Diamond Hill Funds,
where DHCM performs certain services for each series of the trust. These
services include mutual fund administration, accounting, transfer agency and
other related functions. For performing these administrative services, each
series of the trust compensates DHCM a fee at an annual rate of 0.45% times each
series' average daily net assets. DHCM collected $174,481 and $144,701 for
mutual fund administration revenue for the nine months ended September 30, 2003
and 2002, respectively. In fulfilling its role under this agreement, DHCM has
engaged several third-party providers and the cost for their services are paid
by DHCM. Mutual fund administration expense for the nine months ended September
30, 2003 and 2002 was $375,967 and $385,227, respectively. As assets under
management grow in the mutual fund products, the Company expects fees collected
to increase, while the Company expects expenses paid to remain steady;
therefore, causing the net mutual fund administration expense to continue to
decrease.
Mutual fund distribution, which includes distribution fees collected in
connection with sales of the Company's mutual funds net of all mutual fund
distribution expenses paid by the Company, increased to a net expense of $68,278
for the nine months ended September 30, 2003 from $41,310 for the nine months
ended September 30, 2002, a 65% increase. Mutual fund distribution fees
collected and expenses paid both increased during the nine months ended
September 30, 2003 versus the nine months ended September 30, 2002. For
performing these distribution functions, DHS collects front-end and back-end
sales loads, ranging from 1.00% to 5.75% or underwriting fees of 0.50% on fund
investments. DHS also collects 12b-1 fees at an annual rate ranging from 0.25%
to 1.00% times each series' average daily net assets. Mutual fund distribution
revenue for the nine months ended September 30, 2003 and 2002 were $104,404 and
$84,002, respectively. This increase in fees is primarily due to the increase in
assets under management in the Company's mutual fund products. DHS is the
principal underwriter for Diamond Hill Funds, an Ohio business trust, and may
pay third-party financial institutions a fee for distribution or for performing
certain servicing functions for mutual fund shareholders. DHS also pays for the
production of marketing materials used in the distribution of the Diamond Hill
Funds. Mutual fund distribution expense for the nine months ended September 30,
2003 and 2002 were $172,682 and $125,312, respectively. This increase is the
result of increase sales of the mutual fund shares in 2003 versus 2003, in which
DHS finances the commissions paid, and decreased expense in 2002 due to an
adjustment made, during the nine months ended September 30, 2002, for a change
in accounting treatment for commissions paid to brokers for the sale of the
Company's mutual fund C shares.
19
DIAMOND HILL INVESTMENT GROUP, INC. AND SUBSIDIARIES
Previously, the commission was expensed when paid, despite the fact that the
revenue, which offsets this expense, is collected over a twelve-month period.
Therefore, the portion of commission expense that has not yet been offset by the
matching revenue was capitalized and is amortized over twelve months. As assets
under management grow in the mutual fund products, the Company expects fees
collected to increase, while the Company expects expenses paid to remain steady
or increase; therefore, causing the net mutual fund distribution expense to
decrease.
Broker-dealer activity, which is revenue from security transactions and
market-making activity net of broker-dealer expenses which are comprised
principally of clearing costs and regulatory fees, decreased to a net expense of
$13,096 for the nine months ended September 30, 2003 from $135,703 for the nine
months ended September 30, 2002, a 90% improvement. DHS as a registered
full-service broker-dealer transacts security trades through its clearing broker
under a correspondent agreement. For the nine months ended September 30, 2003
and 2002, broker-dealer activity expenses were $36,753 and $150,158,
respectively. This decrease is largely due to the reduction in overhead and
commission expense from reduced activity. DHS earns commissions and service fees
related to business transacted through its clearing broker, along with gains and
losses from market-making activities. Broker-dealer activity revenue for the
nine months ended September 30, 2003 and 2002 were $23,657 and $14,455,
respectively. Commission revenue decreased by 55% from 2002 to 2003. However
market-making losses negatively impacted the nine months ended September 30,
2003 by $45,604. In conjunction with the Company's shift in emphasis from its
traditional investment related activities through DHS, to the investment
advisory services of DHCM, broker dealer activities through DHS have declined.
It is expected for 2003, that this level of expense in 2002 will decrease.
The Company's net operating loss decreased to $1,193,913 for the nine months
ended September 30, 2003 from $1,765,173 for the nine months ended September 30,
2002, a 32% improvement.
Investment return, net of interest expense, increased to a gain of $244,319 for
the nine months ended September 30, 2003 from a loss of $277,017 for the nine
months ended September 30, 2003, a 188% improvement. This investment gain
results primarily from increases in market values of investments in the limited
partnership interest and the Company's mutual funds. Management is unable to
predict how future fluctuations in market values will impact the performance of
the Company's investment portfolios. Dividend income increased by a multiple of
3.5 to $64,912 for the nine months ended September 30, 2003 compared to $18,192
for the nine months ended September 30, 2002. In 2003, dividend income may
increase versus 2002 since the Company reallocated approximately $1.5 million of
its investments from DHIP to the Company's fixed income mutual funds, which pay
monthly dividends, yielding an anticipated average of five percent (5%). The
Company reduced its equity market exposure, due to the potential large swing in
the market value of its portfolio investments. As a result, of this change and
better market returns in 2003 versus 2002, the Company's net loss decreased by
54% for the nine months ended September 30, 2003 compared to the same time
period for 2002.
Liquidity and Capital Resources
-------------------------------
Almost 100% of the Company's investment portfolio is readily marketable.
Investments in securities traded on national securities markets and securities
not traded on national securities markets, but with readily ascertainable market
values, are valued at market value. Other securities, for which market
quotations are not readily available, due to infrequency of transactions, are
valued at fair value as determined in good faith by management of the Company.
While management employs objective criteria to ascertain these values, there is
no independent benchmark by which the values assigned by management can be
judged. Accordingly, the value of these securities may be overstated.
By the end of 2002, the Company reallocated its investment portfolio to provide
more liquidity and reduce its equity exposure. In doing so, the Company
transferred $2 million out of its investment in the limited partnership, DHIP,
and invested approximately $1.5 million into the Company's fixed income mutual
funds. The remaining cash was used the to pay-off the Company's line of credit
and provide short-term liquidity for current operating expenses. On July 22,
2003, the Company sold 110,000 shares of the Company's Common Stock, from
Treasury Stock, to certain directors, officers and employees through a private
placement at a price of $4.50, thereby increasing the liquidity and capital
resources by approximately $495,000.
20
DIAMOND HILL INVESTMENT GROUP, INC. AND SUBSIDIARIES
DHS, under a correspondent agreement with its clearing broker, has agreed to
indemnify the clearing broker from damages or losses resulting from customers'
transactions. The Company is, therefore, exposed to off-balance sheet risk of
loss in the event that customers are unable to fulfill contractual obligations.
The Company manages this risk by requiring customers to have sufficient cash in
their account before a buy order is executed and to have the subject securities
in their account before a sell order is executed. The Company has not incurred
any losses from customers being unable to fulfill contractual obligations.
In the normal course of business, the Company may sell securities it has not yet
purchased (short sales) for its own account, and may write options. The
establishment of short positions and option contracts exposes the Company to
off-balance sheet market risks in the event prices change, as the Company may be
obligated to cover such positions at a loss.
At September 30, 2003, the Company had no short security positions, had not
written any option contracts, and did not own any options. The Company did not
experience any credit losses due to the failure of any counter parties to
perform during the nine months ended September 30, 2003. Senior management of
the Company is responsible for reviewing trading positions, exposures, profits
and losses, trading strategies and hedging strategies on a daily basis.
As of September 30, 2003, the Company had working capital of approximately $2.9
million compared to $2.7 million at June 30, 2003 and compared to $3.3 million
at December 31, 2002. The increase during the three months ended September 30,
2003 is primarily due to the financing activities, which includes the private
placement that occurred on July 22, 2003. The decrease during the nine months
ended September 30, 2003 is primarily due to the operating and financing
activities, which include the net loss and the private placement, respectively.
Working capital includes cash, securities owned and accounts and notes
receivable, net of all liabilities. The Company has no long-term debt.
The Company's net cash balance decreased by $504,568 during the nine months
ended September 30, 2003. Net cash used by operating activities was $1,001,171.
The primary use of cash flow was the net loss of $949,594. Investing activities
used $2,307 for property and equipment purchased during the nine months ended
September 30, 2003. Financing activities provided $498,910 of cash during the
nine months ended September 30, 2003, mostly from the $495,000 private placement
on July 22, 2003.
The Company's net cash balance decreased by $1,109,358 during the nine months
ended September 30, 2002. Net cash used by operating activities was $845,032.
The primary use of cash flow was the net loss of $2,056,811. Investing
activities used $123,826 during the nine months ended September 30, 2002 for
furnishings and a new phone system for the new office space the Company began
leasing in May 2002. Financing activities used $140,500 of cash during the nine
months ended September 30, 2002, primarily from the purchase of Company common
stock. This use of cash was offset by cash provided by the Company's line of
credit..
Investment management fees primarily fund the operations of the Company.
Management believes that the Company's existing resources, including available
cash and cash provided by operating activities, will be sufficient to satisfy
its working capital requirements in the foreseeable future. However, no
assurance can be given that additional funds will not be required. To the extent
that returns on investments are less than anticipated, or expenses are greater
than anticipated, the Company may be required to reduce its activities,
liquidate the investment portfolio or seek additional financing. Further, this
additional financing may not be available on acceptable terms, if at all. No
significant capital expenditures are expected in the foreseeable future.
Impact of Inflation and Other Factors
-------------------------------------
The Company's operations have not been significantly affected by inflation. The
Company's investment portfolios of equity and fixed income securities, are
carried at current market values. Therefore, the Company's profitability is
affected by general economic and market conditions, the volume of securities
trading and fluctuations in interest rates. The Company's business is also
subject to government regulation and changes in legal, accounting, tax and other
compliance requirements. Changes in these regulations may have a significant
effect on the Company's operations.
21
DIAMOND HILL INVESTMENT GROUP, INC. AND SUBSIDIARIES
ITEM 3: CONTROLS AND PROCEDURES
The Company's Chief Executive Officer and Chief Financial Officer have evaluated
the effectiveness of the Company's disclosure controls and procedures (as
defined in Rules 13a-14(c) and 15d-14(c) under the Exchange Act) as of a date
within 90 days prior to the filing date of this quarterly report (the
"Evaluation Date"). Based on such evaluation, such officers have concluded that,
as of the Evaluation Date, our disclosure controls and procedures are effective.
There have been no significant changes in our internal controls or in other
factors that could significantly affect such controls since the Evaluation Date.
PART II: OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS - None
ITEM 2: CHANGES IN SECURITIES
On July 22, 2003, the Company sold 110,000 shares of the Company's Common Stock
in a private placement that was offered to all directors, officers and employees
of the Company. The Common Stock was sold for cash at an offering price of $4.50
per share. No underwriter was used in the offering. This offering was exempted
from registration under section 4(2) of the Securities Act of 1933, as amended.
This exemption was relied upon because the offering was a private placement to
all directors, officers and employees of the Company. There are no exchange or
conversion provisions associated with the securities sold in this offering. Net
proceeds from this offering were used for working capital.
ITEM 3: DEFAULTS UPON SENIOR SECURITIES - None
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - None
ITEM 5: OTHER INFORMATION - None
22
DIAMOND HILL INVESTMENT GROUP, INC. AND SUBSIDIARIES
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Index of Exhibits
*3.1 Amended and Restated Articles of Incorporation of the Company.
*3.2 Code of Regulations of the Company.
**10.1 Diamond Hill Investment Group (fka Heartland) Incentive Compensation
Plan.
***10.2 1993 Non-Qualified and Incentive Stock Option Plan.
****10.3 Synovus Securities, Inc., Sub-Advisory Agreement with the Diamond Hill
Capital Management, Inc. dated January 30, 2001.
**10.4 Employment Agreement between the Company and Roderick H. Dillon, Jr.
dated May 11, 2000.
**10.5 Employment Agreement between the Company and James F. Laird dated
October 24, 2001.
10.6 Form of Subscription Agreement for Common Shares of Diamond Hill
Investment Group, Inc. executed by subscribers as part of the private
placement referenced in Part II, Item 2 of this Form 10-QSB.
99.1 Certification of Chief Executive Officer Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
99.2 Certification of Chief Financial Officer Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
* Filed with the Securities and Exchange Commission as an exhibit to the
Company's Form 8-K filed on May 8, 2002 and incorporated herein by
reference.
** Filed with the Securities and Exchange Commission as an exhibit to the
Company's Form 10-KSB filed on March 28, 2003 and incorporated herein by
reference.
*** Filed with the Securities and Exchange Commission as an exhibit to the
Company's Proxy Statement filed on July 21, 1998 and incorporated herein by
reference.
**** Filed with the Securities and Exchange Commission as an exhibit to the
Company's Form 10-KSB filed on March 1, 2001 and incorporated herein by
reference.
(b) Reports on Form 8-K
A Form 8-K was filed on July 25, 2003 to announce the Company's private
placement that took place on July 22, 2003.
A Form 8-K was filed on August 15, 2003 to report the Company's earnings
for the six months and three months ended September 30, 2003.
23
DIAMOND HILL INVESTMENT GROUP, INC. AND SUBSIDIARIES
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized:
DIAMOND HILL INVESTMENT GROUP, INC.
Signature Title Date
--------------------------------------------------------------------------------
/s/R. H. Dillon President and Director November 14, 2003
-------------------------
R. H. Dillon
/s/James F. Laird Chief Financial Officer November 14, 2003
-------------------------
James F. Laird
24
CERTIFICATION FOR QUARTERLY REPORT ON FORM 10-QSB
I, R.H. Dillon, certify that:
1. I have reviewed this quarterly report on Form 10-QSB of Diamond Hill
Investment Group, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: November 14, 2003 /s/R. H. Dillon
-----------------------
R.H. Dillon
Chief Executive Officer
25
CERTIFICATION FOR QUARTERLY REPORT ON FORM 10-QSB
I, James F. Laird, certify that:
1. I have reviewed this quarterly report on Form 10-QSB of Diamond Hill
Investment Group, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: November 14, 2003 /s/James F. Laird
-----------------------
James F. Laird
Chief Financial Officer
26