Associated Capital Group, Inc. - Annual Report: 2017 (Form 10-K)

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Associated Capital Group, Inc.

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Our future success depends to a substantial degree on our ability to retain and attract other qualified personnel to conduct our investment management business. The market for qualified portfolio managers is extremely competitive and has grown more so in recent periods as the investment management industry has experienced growth. We anticipate that it will be necessary for us to add portfolio managers and investment analysts as we further diversify our investment products and strategies. There can be no assurance, however, that we will be successful in our efforts to recruit and retain the required personnel. In addition, our investment professionals and senior marketing personnel have direct contact with our clients, which can lead to strong client relationships. The loss of these personnel could jeopardize our relationships with certain clients, and result in the loss of such accounts. The loss of key management professionals or the inability to recruit and retain sufficient portfolio managers and marketing personnel could have a material adverse effect on our business.

We have experienced and may again experience periods of rapid growth and significant declines in AUM, which place significant demands on our legal, compliance, accounting, risk management, administrative and operational resources.

Our AUM grew from approximately $230 million as of December 31, 1999 to $814 million as of December 31, 2004. Between December 31, 2004 and December 31, 2008, our AUM had declined to $295 million due to investment losses and redemptions experienced by our funds over that period. As of December 31, 2017, our AUM had grown to approximately $1.5 billion.

Rapid changes in our AUM impose significant demands on our legal, compliance, accounting, risk management, administrative and operational infrastructure. The complexity of these demands and the time and expense required to address them, is a function not simply of the amount by which our AUM have changed, but also of significant differences in the investing strategies employed within our funds and the time periods during which these changes occur. Furthermore, our future growth will depend on, among other things, our ability to develop and maintain highly reliable operating platforms, management systems and financial reporting and compliance infrastructures that are also sufficiently flexible to promptly and appropriately address our business needs, applicable legal and regulatory requirements and relevant market and other operating conditions, all of which can change rapidly.

There may be adverse effects on our business from a decline in the performance of the securities markets.

Our results of operations are affected by many economic factors, including the performance of the securities markets. During the 1990s, unusually favorable and sustained performance of the U.S. securities markets, and the U.S. equity market in particular, attracted substantial inflows of new investments in these markets. That contributed to significant market appreciation which, in turn, led to an increase in our AUM and revenues. More recently, the securities markets in general have experienced significant volatility, and such volatility may continue or increase in the future. At December 31, 2017, our AUM are primarily invested in equity securities. Any decline in the securities markets, in general, and the equity markets, in particular, could reduce our AUM and consequently reduce our revenues. In addition, any such decline in the equity markets, failure of these markets to sustain their prior levels of growth, or continued short-term volatility in these markets could result in investors withdrawing from the equity markets or decreasing their rate of investment, either of which would be likely to adversely affect us. Also, from time to time, a relatively high proportion of the assets we manage may be concentrated in particular economic or industry sectors. A general decline in the performance of securities in those industry sectors could have an adverse effect on our AUM and revenues.

There is a possibility of losses associated with proprietary investment activities.

Currently, we maintain large proprietary investment positions in securities. Market fluctuations and other factors may result in substantial losses in our proprietary accounts, which could have an adverse effect on our balance sheet, reduce our ability or willingness to make new investments or impair our credit ratings.

Future investment performance could reduce revenues and other income.

Success in the investment management business is dependent on investment performance as well as distribution and client servicing. Good performance generally stimulates sales of our investment products and tends to keep withdrawals and redemptions low, which generates higher management fees (which are based on the amount of AUM). Conversely, poor performance, both in absolute terms and/or relative to peers and industry benchmarks, tends to result in decreased sales, increased withdrawals and redemptions and in the loss of clients, with corresponding decreases in revenues to us. Failure of our investment products to perform well could, therefore, have a material adverse effect on us.

 

In addition, when our investment products experience strong results relative to the market or other asset classes, clients’ investments in our products may increase beyond their target levels, and we could, therefore, suffer withdrawals as our clients rebalance their investments to fit their asset allocation preferences.

There is a possibility of losses associated with underwriting and trading activities.

We undertake limited underwriting activities through our subsidiary, G.research and also conduct proprietary trading activities. Such activities subject our capital to significant risks of loss. The risks of loss include those resulting from ownership of securities, extension of credit, leverage, liquidity, counterparty failure to meet commitments, client fraud, employee errors, misconduct and fraud (including unauthorized transactions by traders), failures in connection with the processing of securities transactions and litigation. We have procedures and internal controls to address such risks, but there can be no assurance that these procedures and controls will prevent losses from occurring.

The loss of institutional research services and underwriting revenues from GAMCO and its affiliates would have an adverse effect on our results of operations, and we can provide no assurance that these revenues will continue.

Institutional research services revenues totaled $12.2 million, $12.6 million and $9.9 million for the years ended December 31, 2017, 2016 and 2015, respectively. G.research earned $4.5 million, $5.2 million and $4.9 million, or approximately 60%, 63% and 59%, of its commission revenue from transactions executed on behalf of funds advised by Gabelli Funds, LLC, and clients advised by GAMCO Asset Management Inc. for the years ended December 31, 2017, 2016 and 2015, respectively. Additionally, pursuant to research services agreements, GAMCO Asset Management Inc. and Gabelli Funds LLC paid in aggregate $4.5 million, $3.0 million and $1.5 million to the Company for the years ended December 31, 2017, 2016 and 2015, respectively. G.research also earned $0.2 million, $1.6 million and $0.0 million in underwriting revenues for the years ended December 31, 2017, 2016 and 2015, respectively. These underwriting revenues primarily related to funds affiliated with GAMCO. We can provide no assurance that these institutional research and underwriting revenues from GAMCO and its affiliates will continue, and the loss of these revenues would have an adverse effect on our results of operations.

We may have liability as a general partner or otherwise with respect to our Alternative Investments.

We act as general partner for investment partnerships, including arbitrage, event-driven long/short, sector focused and merchant banking limited partnerships. As a general partner of these partnerships, we may be held liable for the partnerships’ liabilities in excess of their ability to pay such liabilities. In addition, in certain circumstances, we may be liable as a control person for the acts of these investment partnerships. As of December 31, 2017, our AUM included approximately $452 million in these investment partnerships. A substantial adverse judgment or other liability with respect to these investment partnerships could have a material adverse effect on us.

Our organizational documents do not limit our ability to enter into new lines of businesses, and we may expand into new investment strategies, geographic markets and businesses, each of which may result in additional risks and uncertainties in our businesses.

Our plan, to the extent that market conditions permit, is to continue to grow our investment businesses and expand into new investment strategies, geographic markets and businesses. Our organizational documents do not limit us to the investment management and financial advisory businesses. Accordingly, we may pursue growth through acquisitions of other investment management or advisory companies, acquisitions of critical business partners or other strategic initiatives. In addition, we expect opportunities will arise to acquire other alternative or traditional asset managers. To the extent we make strategic investments or acquisitions, undertake other strategic initiatives or enter into a new line of business, we will face numerous risks and uncertainties, including risks associated with (a) the required investment of capital and other resources, (b) the possibility that we have insufficient expertise to engage in such activities profitably or without incurring inappropriate amounts of risk, (c) the diversion of management’s attention from our core businesses, (d) assumption of liabilities in any acquired business, (e) the disruption of our ongoing businesses, (f) the increasing demands on or issues related to the combining or integrating operational and management systems and controls, (g) compliance with additional regulatory requirements, and (h) the broadening of our geographic footprint, including the risks associated with conducting operations in non-U.S. jurisdictions. Entry into certain lines of business may subject us to new laws and regulations with which we are not familiar, or from which we are currently exempt, and may lead to increased litigation and regulatory risk. For example, our recent and planned business initiatives include offering registered investment products and the creation of investment products open to retail investors. These activities have and will continue to impose additional compliance burdens on us and could also subject us to enhanced regulatory scrutiny and expose us to greater reputation and litigation risk. See “— We are subject to substantial litigation risks and may face significant liabilities and damage to our professional reputation as a result of litigation allegations and negative publicity.” In addition, if a new business generates insufficient revenues or if we are unable to efficiently manage our expanded operations, our results of operations will be adversely affected. Our strategic initiatives may include joint ventures, in which case we will be subject to additional risks and uncertainties in that we may be dependent upon, and subject to liability, losses or reputational damage relating to systems, controls and personnel that are not under our control.

 

If we are unable to consummate or successfully integrate additional development opportunities, acquisitions or joint ventures, we may not be able to implement our growth strategy successfully.

Our growth strategy is based, in part, on the selective development or acquisition of asset management businesses, or other businesses complementary to our business where we think we can add substantial value or generate substantial returns. The success of this strategy will depend on, among other things: (a) the availability of suitable opportunities, (b) the level of competition from other companies that may have greater financial resources, (c) our ability to value potential development or acquisition opportunities accurately and negotiate acceptable terms for those opportunities, (d) our ability to obtain requisite approvals and licenses from the relevant governmental authorities and to comply with applicable laws and regulations without incurring undue costs and delays and (e) our ability to identify and enter into mutually beneficial relationships with venture partners. Moreover, even if we are able to identify and successfully complete an acquisition, we may encounter unexpected difficulties or incur unexpected costs associated with integrating and overseeing the operations of the new businesses. If we are not successful in implementing our growth strategy, our business, financial results and the market price for our common units may be adversely affected.

Risk management activities may materially adversely affect the return on our and our clients’ investments.

When managing our and our clients’ exposure to market risks, we may from time to time use hedging strategies and various forms of derivative instruments to limit the funds’ exposure to changes in the relative values of investments that may result from market developments, including changes in prevailing interest rates, currency exchange rates and commodity prices. The success of any hedging transactions generally will depend on our ability to correctly assess the degree of correlation between price movements of the hedging instrument, the position being hedged, the creditworthiness of the counterparty and other factors. As a result, while we may enter into a transaction in order to reduce our exposure to market risks, the transaction may result in poorer overall investment performance than if it had not been executed. Such transactions may also limit the opportunity for gain if the value of a hedged position increases. In addition, the degree of correlation between price movements of the instruments used in connection with hedging activities and price movements in a position being hedged may vary. For a variety of reasons, we may not seek or be successful in establishing a perfect correlation between the instruments used in a hedging or other derivative transaction and the position being hedged. An imperfect correlation could prevent us from achieving the intended result and could give rise to a loss. In addition, it may not be possible to fully or perfectly limit our exposure against all changes in the value of our investment because the value of investments is likely to fluctuate as a result of a number of factors, some of which will be beyond our control or ability to hedge.

 

 

Operational risks may disrupt our businesses, result in regulatory action against us or limit our growth.

We face operational risk arising from errors made in the execution, confirmation or settlement of transactions or from transactions not being properly recorded, evaluated or accounted for. Our business is highly dependent on our ability to process, on a daily basis, transactions across markets in an efficient and accurate manner. Consequently, we rely heavily on our financial, accounting and other data processing systems. Despite the reliability of these systems and the training and skill of our teammates and third parties we rely on, it remains likely that errors may occasionally occur due to the extremely large number of transactions we process. In addition, if systems we use are unable to accommodate an increasing volume of transactions, our ability to expand our businesses could be constrained. If any of these systems do not operate properly or are disabled, we could suffer financial loss, a disruption of our businesses, liability to clients, regulatory intervention or reputational damage.

Failure to maintain adequate infrastructure could impede our productivity and growth. Additionally, failure to maintain effective information and cyber security policies, procedures and capabilities could disrupt operations and cause financial losses that could result in a decrease in our earnings or stock price.

Our infrastructure, including information systems, hardware, software, networks and other technology, is vital to the competitiveness of our business. Our information systems and technology is currently provided by GAMCO pursuant to the Transitional Services Agreement. The failure of GAMCO to maintain an adequate infrastructure commensurate with the size and scope of our business could impede our productivity and growth, which could cause our earnings or stock price to decline.

GAMCO outsources a significant portion of our information systems operations to third parties, who are responsible for providing the management, maintenance and updating of such systems. Technology is subject to rapid change, and we cannot guarantee that our competitors may not implement more advanced technology platforms for their products than we do for ours. In addition, there can be no assurance that the cost of maintaining such outsourcing arrangements will not increase from its current level, which could have a material adverse effect on us.

In addition, any inaccuracies, delays, system failures or security breaches in these and other systems could subject us to client dissatisfaction and losses. Our technology systems may be subject to unauthorized access, computer viruses or other malicious code or other events that could have a security impact. There can be no assurance that breach of our technology systems could result in material losses (such material losses including the loss of valuable information, liability for stolen assets or information, remediation costs to repair damage caused by the breach, additional security costs to mitigate against future incidents and litigation costs resulting from the incident) relating to such security breach of our technology systems.

If a successful cyber-attack or other security breach were to occur, our confidential or proprietary information, or the confidential or proprietary information of our clients or their counterparties, that is stored in, or transmitted through, such technology systems could be compromised or misappropriated. Moreover, loss of confidential customer identification information could harm our reputation and subject us to liability under laws that protect confidential personal data, resulting in increased costs or loss of revenues. Further, although we take precautions to password protect and encrypt our laptops and other mobile electronic hardware; there can be no assurance that these measures will always provide sufficient protection. If such hardware is stolen, misplaced or left unattended, it may become vulnerable to hacking or other unauthorized use, creating a possible security risk and resulting in potentially costly actions by us.

 

The failure of one of our vendors to fulfill its obligations to us could have a material adverse effect on us and our clients.

We and GAMCO depend on a number of key vendors for various fund administration, accounting, custody and transfer agent roles and other operational needs. Our or GAMCO’s failure or inability to diversify sources for key services or the failure of any key vendors to fulfill their obligations could lead to operational issues for us and, with respect to certain products, could result in financial losses for us and our clients.

We face exposure to legal actions, including litigation and arbitration claims and regulatory and governmental examinations and/or investigations. Insurance coverage for these matters may be inadequate.

The volume of litigation and arbitration claims against financial services firms and the amount of damages claimed has increased over the past several years. The types of claims that we may face are varied. For example, we may face claims against us for purchasing securities that are inconsistent with a client’s investment objectives or guidelines or arising from an employment dispute. The risk of litigation is difficult to predict, assess or quantify, and may occur years after the activities or events at issue. In addition, from time to time we may become the subject of governmental or regulatory investigations and/or examinations. Even if we prevail in a legal or regulatory action, the costs alone of defending against the action or the harm to our reputation could have a material adverse effect on us. The insurance coverage that we maintain with respect to legal and regulatory actions may be inadequate or may not cover certain proceedings.

Compliance failures could adversely affect us.

Our investment management activities are subject to regulatory rules and negotiated client guidelines. A failure to comply with these rules and guidelines could result in damage to our reputation, regulatory fines or in our clients seeking to recover losses, withdrawing their investments or terminating their contracts, any of which could cause our revenues and earnings to decline. There can be no assurance that the precautions and procedures that we have instituted and installed or the insurance we maintain to protect ourselves in case of client losses will protect us from potential liabilities.

Our reputation is critical to our success.

Our reputation is critical to acquiring, maintaining and developing relationships with our clients and third-party intermediaries. In recent years, there have been a number of well-publicized cases involving fraud, conflicts of interest or other misconduct by individuals in the financial services industry. Misconduct by our staff, or even unsubstantiated allegations, could result not only in direct financial harm but also in harm to our reputation, causing injury to the value of our brands and our ability to retain or attract AUM. In addition, in certain circumstances, misconduct on the part of our clients or other parties could damage our reputation. Moreover, reputational harm may cause us to lose current employees and we may be unable to attract new employees with similar qualification or skills. Damage to our reputation could substantially reduce our AUM and impair our ability to maintain or grow our business, which could have a material adverse effect on us.

We face strong competition from numerous and sometimes larger companies.

We compete with numerous investment management companies, stock brokerage and investment banking firms, insurance companies, banks, savings and loan associations and other financial institutions. The periodic establishment of new investment management companies and other competitors increases the competition that we face. At the same time, consolidation in the financial services industry has created stronger competitors with greater financial resources and broader distribution channels than our own. Competition is based on various factors, including, among others business reputation, investment performance, product mix and offerings, service quality and innovation, distribution relationships and fees charged. Our competitive success in all of these areas cannot be assured. Additionally, competing securities dealers whom we rely upon to distribute our products also sell their own proprietary investment products, which could limit the distribution of our investment products. To the extent that existing or potential customers, including securities dealers, decide to invest in or distribute the products of our competitors, the sales of our products as well as our market share, revenues and net income could decline. Both GAMCO and Associated Capital have asset management as their principal business and derive most of their revenues through that business and, as such, may compete with each other.

 

If third-party investors in our funds exercise their right to remove us as investment manager or general partner of our products, we would lose the AUM in such funds, which would eliminate our management fees and incentive allocation income derived from such products.

The governing agreements of most of our Investment Partnerships provide that, subject to certain conditions, third-party investors in those Investment Partnerships have the right, without cause, to vote to remove us as investment manager or general partner of the Investment Partnerships by a simple majority vote, resulting in the elimination of the AUM by those products and the management fees and incentive allocation income derived from those products. In addition to having a significant negative impact on our revenues, results of operations and cash flows, the occurrence of such an event would likely result in significant reputational damage to us.

If we were deemed to be an investment company under the Investment Company Act of 1940 (the “Investment Company Act”), as amended, and were required to register, applicable restrictions could make it impractical for us to continue our business as contemplated and could have a material adverse effect on our business.

Given the nature of its assets, the Company may be deemed to be an “inadvertent” investment company as defined in Section 3(a)(1)(C) of the Investment Company Act and, if so, it may be required to be registered with the Commission as an investment company. While we believe that the Company’s assets and operations are structured so that it is not an investment company, there can be no assurance that the Commission would agree with the Company’s assessment. In addition, if the composition of the Company’s assets and/or operations were to change, the Company may be required to register as an investment company. In such case, the Company would be subject to significant restrictions imposed on its operations by the Investment Company Act, including limitations on capital structure and the ability to transact business with affiliates. These limitations could make it impractical for the Company to continue its business as contemplated and would have a material adverse effect on its business.

Risks Related to the Associated Capital Common Stock

The disparity in the voting rights among the classes of shares may have a potential adverse effect on the price of the Associated Capital Class A Stock.

The holders of Associated Capital Class A Stock and Associated Capital Class B Stock have identical rights except that holders of Associated Capital Class A Stock are entitled to one vote per share, while holders of Associated Capital Class B Stock are entitled to ten votes per share on all matters to be voted on by stockholders in general, and holders of shares of one class are not eligible to vote on matters relating exclusively to the other class. Mario J. Gabelli, through his control and majority ownership of GGCP and his individual ownership of Associated Capital common stock, beneficially owns a majority of the outstanding Associated Capital Class B Stock, representing approximately 96.4% voting control. As long as Mario J. Gabelli indirectly beneficially owns a majority of the combined voting power of the Associated Capital common stock, he will have the ability to elect all of the members of our Board and thereby control our management and affairs, including, among other things, any determinations with respect to acquisitions, dispositions, borrowings, issuances of common stock or other securities, and the declaration and payment of dividends on the Associated Capital common stock. The differential in voting rights and the ability of Associated Capital to issue additional Associated Capital Class B Stock could adversely affect the value of the Associated Capital Class A Stock to the extent the investors, or any potential future purchaser of Associated Capital, view the superior voting rights of the Associated Capital Class B Stock to have value. While there is no current intention to issue additional Associated Capital Class B Stock, there is no prohibition on Associated Capital issuing additional shares of Associated Capital Class B Stock in the future.

An active public trading market for the Associated Capital Class A Stock is not assured.

A liquid public market for the Associated Capital Class A Stock is not assured, especially because a large percentage of the Associated Capital common stock is held by a limited number of stockholders. If an active trading market for the Associated Capital Class A Stock does not exist, the market price and liquidity of the Associated Capital Class A Stock may be materially and adversely affected.

 

We cannot predict the prices at which the Associated Capital Class A Stock may trade.

The market price of the Associated Capital Class A Stock may fluctuate significantly due to a number of factors, some of which may be beyond our control, including:

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our quarterly or annual earnings, or those of other companies in our industry;

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actual or anticipated reductions in our revenue, net earnings and cash flow resulting from actual or anticipated decline in AUM;

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changes in accounting standards, policies, guidance, interpretations or principles;

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the failure of securities analysts to cover Associated Capital or changes in financial estimates by analysts;

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changes in earnings estimates by securities analysts or our ability to meet those estimates;

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the operating and stock price performance of other comparable companies;

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overall market fluctuations; and

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general economic conditions.

In particular, the realization of any of the risks described in these “Risk Factors” could have a significant and adverse impact on the market price of the Associated Capital Class A Stock. In addition, the stock market in general has experienced extreme price and volume volatility that has often been unrelated to the operating performance of particular companies. This volatility has had a significant impact on the market price of securities issued by many companies, including companies in our industry. The price of the Associated Capital Class A Stock could fluctuate based upon factors that have little or nothing to do with us, and these fluctuations could materially reduce our stock price.

We cannot predict how the investment community will value the GAMCO Note ($50 million outstanding as of December 31, 2017) given the GAAP accounting treatment as a reduction to book value.

For GAAP purposes, the amount of the GAMCO Note, which was issued by GAMCO to Associated Capital as part of the spin-off transaction, will be treated as a reduction in equity, rather than as an asset, during the period all or any portion of the GAMCO Note is outstanding. Management utilizes adjusted economic book value (“AEBV”), a non-GAAP measure, in its analysis of our financial condition. AEBV includes the outstanding value of the GAMCO Note as an asset. Management believes AEBV is useful in analyzing our financial condition during the period in which we build our core operating business. Upon issuance, the GAMCO Note was required to be paid down ratably over five years subject to prepayment at GAMCO’s option. As GAMCO pays down the note, Associated Capital’s GAAP book value will increase, and once the GAMCO Note is fully paid off, Associated Capital’s GAAP book value and AEBV will be the same. It is possible that the investment community will rely on the GAAP treatment of the GAMCO Note rather than on the non-GAAP AEBV, which may have an adverse effect on the value of our stock.

Future sales of Associated Capital Class A Stock in the public market or sales or distributions of Associated Capital Class B Stock could lower our stock price, and any additional capital raised by us through the sale of equity or convertible securities may dilute our stockholders’ ownership in us.

We may sell additional shares of Associated Capital Class A Stock in public or private offerings. We also may issue additional shares of Associated Capital Class A Stock or convertible debt securities. In addition, sales by our current stockholders could be perceived negatively. No prediction can be made as to the effect, if any, that future sales or distributions of Associated Capital Class B Stock owned by GGCP will have on the market price of the Associated Capital Class A Stock from time to time. Sales or distributions of substantial amounts of Associated Capital Class A Stock or Associated Capital Class B Stock, or the perception that such sales or distributions are likely to occur, could adversely affect the prevailing market price for the Associated Capital Class A Stock.

 

The reduced disclosure requirements applicable to us as an “emerging growth company” may make Associated Capital common stock less attractive to investors.

We are an “emerging growth company” as defined in the JOBS Act, and we may avail ourselves of certain exemptions from various reporting requirements of public companies that are not “emerging growth companies,” including, but not limited to, an exemption from complying with the auditor attestation requirements of Section 404(b) of the Sarbanes-Oxley Act of 2002, as amended (the “Sarbanes-Oxley Act”) and reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirement of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved. We may remain an emerging growth company for up to five full fiscal years following the spin-off. We would cease to be an emerging growth company, and, therefore, become ineligible to rely on the above exemptions, if we (a) have more than $1 billion in annual revenue in a fiscal year, (b) issue more than $1 billion of non-convertible debt over a three-year period or (c) become a “large accelerated filer” as defined in Rule 12b-2 under the Exchange Act, which would occur after: (i) we have filed at least one annual report; (ii) we have been an SEC-reporting company for at least 12 months; and (iii) the market value of Associated Capital Class A Stock that is held by non-affiliates exceeds $700 million as of the last business day of our most recently completed second fiscal quarter. We cannot predict if investors will find Associated Capital common stock less attractive because we may rely on these exemptions.

If some investors find Associated Capital Class A Stock less attractive as a result of the exemptions available to us as an emerging growth company, there may be a less active trading market for Associated Capital Class A Stock and our value may be more volatile than that of an otherwise comparable company that does not avail itself of the same or similar exemptions.

We are a “controlled company” within the meaning of NYSE rules and, as a result, will qualify for, and intend to rely on, exemptions from certain corporate governance requirements. You will not have the same protections afforded to stockholders of companies that are subject to such requirements.

Mario J. Gabelli and his affiliates control a majority of the voting power of the Associated Capital common stock. As a result, we are a “controlled company” within the meaning of the corporate governance standards of the NYSE. Under these rules, a company of which more than 50% of the voting power in the election of directors is held by an individual, group or another company is a “controlled company” and may elect not to comply with certain corporate governance requirements, including the requirements that, within one year of the date of the listing of the Associated Capital Class A Stock:

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we have a board that is composed of a majority of “independent directors,” as defined under the rules of the NYSE;

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we have a compensation committee that is composed entirely of independent directors; and

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we have a nominating/corporate governance committee that is composed entirely of independent directors.

While a majority of our directors are currently independent, we intend to utilize certain of these exemptions. For example, our Nominating Committee is not comprised of independent directors. Accordingly, you will not have the same protections afforded to stockholders of companies that are subject to all of the corporate governance requirements of the NYSE.

Our certificate of incorporation provides that certain lawsuits must be litigated in Delaware, which may limit your ability to obtain a favorable judicial forum for disputes with us.

Our certificate of incorporation provides that, unless we consent in writing to the selection of an alternative forum, the sole and exclusive forum for (i) any derivative action or proceeding brought on our behalf, (ii) any action asserting a claim of breach of a fiduciary duty owed by any director, officer or other employee of Associated Capital to Associated Capital or its stockholders, (iii) any action asserting a claim arising pursuant to any provision of the Delaware General Corporation Law or our certificate of incorporation or our bylaws or (iv) any action asserting a claim governed by the internal affairs doctrine shall be the Court of Chancery in the State of Delaware (or, if the Court of Chancery does not have jurisdiction, the federal district court for the District of Delaware). Accordingly, it may not be possible for stockholders to litigate any action relating to the foregoing matters outside of the State of Delaware, even though stockholders may view other forums to be more favorable.

 

ITEM 1B:

UNRESOLVED STAFF COMMENTS

None.

ITEM 2:

PROPERTIES

AC owns no properties. AC currently pays GAMCO an occupancy charge based on percentage of square footage occupied by its employees (including pro rata allocation of common space) with respect to the office space it uses at GAMCO’s offices at 401 Theodore Fremd Avenue in Rye, NY. AC’s usage of such property is covered under a sublease agreement executed with GAMCO.

ITEM 3:

LEGAL PROCEEDINGS

Currently, we are not subject to any legal proceedings that individually or in the aggregate involved a claim for damages in excess of 10% of our consolidated assets. From time to time, we may be named in legal actions and proceedings. These actions may seek substantial or indeterminate compensatory as well as punitive damages or injunctive relief. We are also subject to governmental or regulatory examinations or investigations. Examinations or investigations can result in adverse judgments, settlements, fines, injunctions, restitutions or other relief. For any such matters, the consolidated financial statements include the necessary provisions for losses that we believe are probable and estimable. Furthermore, we evaluate whether there exist losses which may be reasonably possible and, if material, make the necessary disclosures.

ITEM 4:

MINE SAFETY DISCLOSURES

Not applicable.

PART II

ITEM 5:

MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market for our Stock, Dividends and Stock Repurchase Program

Our shares of Class A Stock are traded on the NYSE under the symbol AC.

As of February 1, 2018, there were 132 holders of record and 23 holders of record of the Company’s Class A and Class B common stock, respectively. These figures do not include approximately 3,500 holders with Class A shares held under beneficial ownership in nominee name.

The following table sets forth the high and low prices of our Class A common stock since our spin-off from GAMCO and historical dividends declared per share to both Class A common stock and Class B common stock as reported by the NYSE.

		2016																2017
										Dividend Declared																Dividend Declared
		High				Low				Regular				Special				High				Low				Regular				Special
First Quarter		$	30.40			$	24.67			$	0.10			$	-			$	39.35			$	32.20			$	-			$	-
Second Quarter			30.89				27.58				-				-				36.30				32.60				0.10				-
Third Quarter			35.51				28.51				-				-				37.45				32.20				-				-
Fourth Quarter			35.96				32.25				0.10				-				38.82				33.10				0.10				-

 

In December 2015, the Board of Directors established a stock repurchase program authorizing the Company to re-purchase up to 500,000 shares. Our stock repurchase program is not subject to an expiration date. The following table provides information with respect to the shares of our Class A Stock we repurchased during the quarter ended December 31, 2017:

Period		Total Number of Shares Repurchased				Average Price Paid Per Share, net of Commissions				Total Number of Shares Repurchased as Part of Publicly Announced Plans or Programs				Maximum Number of Shares That May Yet Be Purchased Under the Plans or Programs
10/01/17 - 10/31/17			84,612			$	37.53				84,612				953,137
11/01/17 - 11/30/17			33,067				35.42				33,067				920,070
12/01/17 - 12/31/17			29,284				33.96				29,284				890,786
Totals			146,963			$	36.34				146,963

In addition to our on-going stock repurchase program, on December 30, 2016, with the approval of the Board of Directors, the Company entered into an agreement to purchase a block of 926,345 shares of Class A common stock from an unaffiliated third party for $31.05 per share, for total consideration of $28,763,012.

On February 7, 2017, the Board of Directors reset the available number of shares to be purchased under the stock repurchase program to 500,000 shares. On August 3, 2017, the Board of Directors authorized the repurchase of an additional 1 million shares.

During the period from January 1, 2018 to March 8, 2018, we repurchased 3,971 shares at an average price per share of $33.99.

We are required to provide a comparison of the cumulative total return on our Class A common stock as of December 31, 2017 with that of a broad equity market index and either a published industry index or a peer group index selected by us. The following chart compares the return on the Class A common stock with the return on the S&P 500 Index and the SNL Asset Manager Index, an index comprised of 41 primarily U.S. publicly traded asset managers. The comparison assumes that $100 was invested in the Class A common stock and in each of the named indices on November 30, 2015 and includes the reinvestment of dividends. This chart is not intended to forecast future performance of our Class A common stock.

 

 

 

We have adopted the 2015 Stock Award and Incentive Plan (the “Equity Compensation Plan”). A maximum of 2.0 million shares of Class A Stock have been reserved for issuance as approved by the Company’s stockholders at the annual meeting of stockholders held on May 3, 2016.

No awarded but unvested shares are outstanding under the Equity Compensation Plan as of December 31, 2017. The number of securities remaining available for future issuance under equity compensation plans is 1,459,400. The Company withdrew the registration statement covering the issuance of those securities as of December 29, 2017.

ITEM 6:

SELECTED FINANCIAL DATA

General

The selected historical financial data presented below has been derived in part from, and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in Item 7 and “Financial Statements and Supplementary Data” included in Item 8 of this report. Amounts included in the tables related to income statement data and balance sheet data are derived from audited financial statements.

 

 

See accompanying notes.

 

(a)	Includes unvested RSAs of 0, 424,340 and 553,100 at December 31, 2017, 2016 and 2015, respectively.

 

 

		Year Ended December 31,
Assets Under Management (in millions)		2017				2016				2015
Event Merger Arb		$	1,384			$	1,076			$	869
Event-Driven Value			91				133				145
Other			66				63				66
Total AUM		$	1,541			$	1,272			$	1,080

 

ITEM 7:

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Introduction

This MD&A is provided as a supplement to, and should be read in conjunction with, the Consolidated Financial Statements and the notes thereto included in Item 8 to this report. Unless the context otherwise requires, all references to “we,” “us,” “our,” “AC Group” or the “Company” refer collectively to Associated Capital Group, Inc. and its subsidiaries through which our operations are actually conducted.

The Spin-off

On November 30, 2015, GAMCO distributed all the outstanding shares of each class of common stock of AC Group on a pro rata one-for-one basis to the holders of each class of GAMCO’s common stock. Prior to the distribution, GAMCO contributed the 93.9% interest it held in Gabelli & Company Investment Advisers, Inc. (“GCIA” f/k/a Gabelli Securities, Inc.) and certain cash and other assets to AC Group. During the twelve months ended December 31, 2016, AC purchased the 6.1% of GCIA shares owned by third parties and certain employees in exchange for 163,428 shares of the Company. GCIA is now a wholly owned subsidiary of AC.

In connection with the spin-off, GAMCO issued a promissory note (the “GAMCO Note”) to AC Group in the original principal amount of $250 million used to partially capitalize the Company. The GAMCO Note bears interest at 4% per annum and has a maturity date of November 30, 2020 with respect to its original principal amount. Interest on the GAMCO Note will accrue from the most recent date for which interest has been paid. Prior to November 30, 2019, at the election of GAMCO, payment of interest on the GAMCO Note may, in lieu of being paid in cash, be paid, in whole or in part, in kind (a “PIK Amount”). GAMCO will repay all PIK Amounts added to the outstanding principal amount of the GAMCO Note, in cash, on the fifth anniversary of the date on which each such PIK Amount was added to the outstanding principal amount of the GAMCO Note. GAMCO may prepay the GAMCO Note prior to maturity without penalty.

During the year ended December 31, 2017, AC received principal repayments totaling $50 million on the GAMCO Note. Following these prepayments, the $50 million principal amount outstanding as of December 31, 2017 is due on November 30, 2020.

On November 27, 2015 GCIA purchased from GAMCO 4,393,055 shares of GAMCO class A common stock at a price of $34.1448 per share, based on the average of the volume weighted average price for GAMCO class A stock on an “ex-Distribution” basis from November 9, 2015 through and including November 27, 2015.

Factors Affecting Financial Condition and Results of Operations

Except for the one month period subsequent to the spin-off, the Company’s combined statements of income for the three months ended December 31, 2015 and the Company’s combined consolidated statements of income for the twelve months ended December 31, 2015 were prepared on a standalone basis derived from the combined financial statements and accounting records of GAMCO as the Company was not a standalone public company prior to the spin-off.

The combined consolidated statement of income for the period ended December 31, 2015 includes allocations for certain support functions that were provided on a centralized basis by GAMCO and not historically recorded at the business unit level. These expenses were allocated on the basis of direct usage when identifiable, with the remainder allocated on a pro-rata basis of headcount or other measures. Management believes the assumptions underlying the combined consolidated financial statements, including the assumptions regarding allocating general corporate expenses, are reasonable. Nevertheless, the combined consolidated financial statement may not include all of the actual expenses that would have been incurred by the Company and may not reflect its combined results of operations, financial position and cash flows had it been a separate, standalone company during the periods presented. Actual costs that would have been incurred if the Company had been a separate, standalone company would depend on multiple factors, including organizational structure and strategic decisions made in various areas, including information technology and infrastructure. References within these Notes to the consolidated financial statements for the years ended December 31, 2017 and 2016 and the combined consolidated statements of income, comprehensive income, equity, and cash flows for the year ended December 31, 2015 shall hereinafter be referred to as the consolidated statements of income, comprehensive income, equity, and cash flows or consolidated financial statements.

 

The Company, through its subsidiaries, provides alternative investment management services and institutional research services, as well as management of the Company’s proprietary investment portfolio. In all these endeavors, the Company seeks investments trading at prices that differ from those determined using our proprietary “Private Market Value (PMV) with a Catalyst^TM” methodology where we have identified a near-term catalyst to narrow the market difference to PMV. Catalysts can include a spin-off, stock buyback, asset sale, management change, regulatory change or accounting change.

In its alternative asset management operations, subsidiaries of the Company serve as general partner or investment manager to investment funds including limited partnerships, offshore companies and separate accounts. The Company primarily manages assets in equity event-driven value strategies, across a range of risk and event arbitrage portfolios, earning management and incentive fees from its assets under management (AUM). The institutional research business offers domain knowledge-driven research and a sales and trading platform for institutional investors, earning fees from its institutional clients via trading commissions or direct payment. The Company manages its proprietary portfolio to maximize shareholder value and to support its other operating businesses.

Interim Chief Financial Officer

Francis J. Conroy, CPA joined the Company as Interim Chief Financial Officer effective November 7, 2017. Mr. Conroy succeeded Patrick Dennis who originally joined AC in November 2015 prior to the Company’s spin-off from GAMCO.

Reclassification

The Company has reclassified certain prior-period amounts to conform to the current-period presentation. For presentation of 2017 results, the Company reported revenue from its research services agreement with affiliates in “Institutional Research Services Revenue” instead of “Other Revenue”. The reclassification did not impact total revenues, operating expenses, operating income/(loss), net income, or equity.

Overview

Consolidated Statements of Income

Investment advisory and incentive fees, which are based on the amount and composition of AUM in our funds and accounts, represent our largest source of revenues. Growth in revenues depends on good investment performance, which influences the value of existing AUM as well as contributes to higher investment and lower redemption rates and facilitates the ability to attract additional investors while maintaining current fee levels. Growth in AUM is also dependent on being able to access various distribution channels, which is usually based on several factors, including performance and service.

Incentive fees generally consist of an incentive allocation on the absolute gain in a portfolio or a fee of 20% of the economic profit, as defined in the agreements governing the investment vehicle. We recognize revenue only when the measurement period has been completed or at the time of an investor redemption.

Institutional research services revenues consist of brokerage commissions derived from securities transactions executed on an agency basis or direct payments on behalf of institutional clients. Commission revenues vary directly with the perceived value of the research, as well as account trading activity and new account generation.

Compensation costs include variable and fixed compensation and related expenses paid to officers, portfolio managers, sales, trading, research and all other professional staff. Variable compensation paid to sales personnel and portfolio management generally represents 40% of revenues and is the largest component of total compensation costs.

 

Management fee is incentive-based and entirely variable compensation in the amount of 10% of the aggregate pre-tax profits which is paid to Mr. Gabelli or his designee for acting as Executive Chairman pursuant to his Employment Agreement so long as he is an executive of AC.

Other operating expenses include general and administrative operating costs and clearing charges and fees incurred by the brokerage business.

Other income and expenses include net gains and losses from investments (which include both realized and unrealized gains and losses from trading securities and equity in earnings of investments in partnerships), interest and dividend income, and interest expense. Net gains and losses from investments are derived from our proprietary investment portfolio consisting of various public and private investments.

Net income/(loss) attributable to noncontrolling interests represents the share of net income attributable to the minority stockholders, as reported on a separate company basis, of our consolidated majority-owned subsidiaries and net income attributable to third party limited partners of certain partnerships and offshore funds we consolidate. Please refer to Notes A and D in our consolidated financial statements included elsewhere in this report.

Consolidated Statements of Financial Condition

We ended the 2017 year with approximately $932 million in cash and investments, net of securities sold, not yet purchased of $6 million. This includes $347 million of cash and short term US treasuries; $293 million of securities, net, including 4.4 million shares of GAMCO valued at $130 million; and $292 million invested in affiliated and third party funds and partnerships. Our financial resources underpin our flexibility to pursue strategic objectives that may include acquisitions, lift-outs, seeding new investment strategies, and co-investing, as well as shareholder compensation in the form of share repurchase and dividends.

Total shareholders’ equity was $918 million or $38.84 per share on December 31, 2017, compared to $874 million or $36.04 per share on December 31, 2016. Note that these shareholders’ equity per share calculations are a non-GAAP measurement calculated by dividing the total equity by the number of common shares outstanding. The increase in equity from the end of 2016 was largely attributable to prepayments of the GAMCO Note totaling $50 million.

The Company also reviews an analysis of adjusted economic book value (“AEBV”), and AEBV per share, a non-GAAP financial measure that management believes is useful for analyzing AC’s financial condition because it reflects the impact on book value if and when the GAMCO Note is paid down. The GAMCO Note that was issued as part of the spin-off transaction is not treated as an asset for GAAP purposes, but as a reduction in equity, and will continue to be reflected as a reduction in equity in future periods in the amount of the principal then outstanding. As the GAMCO Note pays down, the Company’s total equity will increase, and once the GAMCO Note is fully repaid, the Company’s total equity and AEBV will be the same. At December 31, 2017, AEBV for the Company was $968 million and the AEBV per share was $40.96 per share. The reconciliation of GAAP book value and GAAP book value per share to AEBV and AEBV per share at December 31, 2017 is shown below (in thousands, except for per share data):

 

 

Our primary goal is to use our liquid resources to opportunistically and strategically grow book value and net income. While this goal is a priority, if opportunities are not present with what we consider a margin of safety, we will consider alternatives to return capital to our shareholders, including stock repurchases and dividends.

 

Assets Under Management Highlights

We reported assets under management as follows (dollars in millions):

 

		Year Ended December 31,																					CAGR (a)
		2017					2016				2015				2014				2013					2017/2013
Event Merger Arb		$	1,384				$	1,076			$	869			$	796			$	691				19.0	%
Event-Driven Value			91					133				145				167				140				(10.2	)
Other			66					63				66				77				76				(3.5	)
Total AUM		$	1,541		(b)		$	1,272			$	1,080			$	1,040			$	907				14.2	%

 

(a) Compound annual growth rate.

(b) Includes $235 million of proprietary capital.

Our gross cash inflows by product line were as follows (dollars in millions):

		Year Ended December 31,
		2017				2016				2015				2014				2013
Event Merger Arb		$	559			$	297			$	166			$	162			$	79
Event-Driven Value			13				1				39				45				38
Other			-				1				2				5				6
Total Cash Inflows		$	572			$	299			$	207			$	212			$	123

Our gross cash outflows by product line were as follows (dollars in millions):

		Year Ended December 31,
		2017				2016				2015				2014				2013
Event Merger Arb		$	(313	)		$	(148	)		$	(119	)		$	(68	)		$	(137	)
Event-Driven Value			(65	)			(18	)			(54	)			(21	)			(36	)
Other			(2	)			(9	)			(12	)			(5	)			(13	)
Total Cash Outflows		$	(380	)		$	(175	)		$	(185	)		$	(94	)		$	(186	)

Our net investment returns by product line were as follows (dollars in millions):

 

		Year Ended December 31,
		2017				2016				2015				2014				2013
Event Merger Arb		$	62			$	58			$	26			$	11			$	28
Event-Driven Value			10				5				(7	)			3				14
Other			5				5				(1	)			1				8
Total Net Appreciation/(Depreciation)		$	77			$	68			$	18			$	15			$	50

The majority of these assets have calendar year-end measurement periods; therefore, our incentive fees are primarily recognized in the fourth quarter.

 

Operating Results for the Year Ended December 31, 2017 as Compared to the Year Ended December 31, 2016 

Revenues

Total revenues were $26.9 million for the year ended December 31, 2017, $4.3 million lower than total revenues of $31.2 million for the year ended December 31, 2016. Total revenues by type were as follows (dollars in thousands):

		Year Ended December 31,								Decrease
		2017				2016				$					%
Investment advisory and incentive fees		$	14,551			$	18,320			$	(3,769	)			-20.6	%
Institutional research services			12,199				12,634				(435	)			(3.4	)
Other revenues			165				273				(108	)			(39.6	)
Total revenues		$	26,915			$	31,227			$	(4,312	)			-13.8	%

Investment advisory and incentive fees: We earn advisory fees based on the level of average AUM in our products. Investment advisory income is directly influenced by the amount of average AUM and the fee rates applicable to various accounts.

Advisory fees were $9.9 million for 2017 compared to $8.9 million for 2016, an increase of $1.0 million. This increase is a result of the increase in average AUM over the period.

Incentive fees are directly related to the gains generated for our clients. We earn a percentage, usually 20%, of the economic gains of our clients’ AUM. Incentive fees were $4.7 million in 2017, down $4.7 million from $9.4 million in 2016 due to lower investment performance.

Institutional research services: Institutional research services revenues in 2017 were $12.2 million, a $0.4 million decline from $12.6 million in 2016 resulting from lower brokerage commissions derived from securities transactions executed on an agency basis and sales manager fees earned from at-the market offerings of certain GAMCO closed-end funds partially offset by increased revenue from research services agreements with affiliates.

Other revenues: Other revenues were $0.2 million for 2017 compared to $0.3 million for 2016, a decrease of $0.1 million.

Expenses

Compensation: Compensation costs, which include variable compensation, salaries, bonuses and benefits, were $30.6 million for the year ended December 31, 2017, a decrease from $31.0 million for the year ended December 31, 2016. Fixed compensation costs, which include salaries, bonuses and benefits, increased to $19.8 million in 2017 from $19.3 million in 2016. The remainder of compensation expense represents variable compensation that fluctuates with management fee and incentive fee revenues. For 2017, variable payouts on revenues were $10.8 million, down $0.9 million from $11.7 million in 2016. Variable payouts are impacted by the mix of products upon which performance fees are earned and the extent to which they may exceed their allocated costs.

Stock-based compensation: Stock-based compensation was $5.9 million in 2017, an increase of $3.4 million, as compared to $2.5 million in 2016. The increase was primarily due to the accelerated vesting of AC and GBL restricted stock that occurred in June and August of 2017, respectively.

Management fees: Management fee expense is incentive-based and entirely variable compensation equal to 10% of the aggregate pre-tax profits, which is paid to Mario J. Gabelli or his designees pursuant to his employment agreement with AC. In 2017 and 2016, AC recorded management fee expense of $0.7 million and $1.6 million, respectively, as presented in the consolidated statements of income.

 

Other operating expenses: Our other operating expenses were $10.1 million in 2017 compared to $8.4 million in 2016, an increase of $1.7 million due primarily to initial offering costs of a consolidated fund that launched in July 2017.

Investment and other non-operating income, net

Net gain from investments: Net gain from investments is directly related to the performance of our proprietary capital accounts. For the year ended December 31, 2017, net gains from investments were $20.6 million compared to $19.9 million in the prior year primarily due to mark-to-market gains in the value of our investments. The net gain was also impacted by two items attributable to available for sale (“AFS”) securities: a $19.1 million other than temporary impairment on our investment in GBL and a gain of $11.8 million associated with AFS securities contributed to G.research, our broker-dealer, where they are held as trading securities.

Interest and dividend income: Interest and dividend income declined $2.2 million to $10.5 million in 2017 from $12.7 million in 2016 primarily due to the reduction in the balance of the GAMCO Note.

Interest expense: Interest expense decreased to $0.2 million in 2017 from $0.6 million in 2016.

Income Taxes

In 2017, we recorded an income tax benefit of $2.4 million resulting in a negative effective tax rate (“ETR”) of -38.6% (i.e., a tax benefit on positive income). In 2016, we recorded an income tax expense of $3.9 million resulting in an ETR of 27.0%. The 2017 negative ETR is below the standard corporate tax rate of 34% primarily due to tax benefits from the dividends received deduction and the charitable contribution of appreciated securities and the revaluation of deferred tax items as a result of the reduction in the federal corporate income tax rate to 21% under the recently-enacted Tax Cut and Jobs Act. The revaluation of deferred tax items was based on reasonable estimates but may require future adjustment for a variety of reasons including the receipt of additional information from investment funds, changes in the Company’s assumptions and the availability of further guidance and interpretations.

We expect that the Company’s ETR in future years will be slightly less than the 21% statutory rate as a result of the continued availability of the dividend received deduction. This expectation does not, however, include the effect of significant discretionary tax-advantaged actions (e.g., a charitable contribution of appreciated securities).

Noncontrolling Interests

Net income/(loss) attributable to noncontrolling interests was a loss of $0.2 million in 2017 compared to income of $0.3 million in 2016.

Net Income

Net income for the year ended December 31, 2017 was $8.8 million compared to net income of $10.2 million for the prior year substantially the result of decreased incentive fee revenues and increased stock-based compensation due to the accelerated vesting of AC and GBL restricted stock offset by an income tax benefit driven by the revaluation of deferred tax items.

 

Operating Results for the Year Ended December 31, 2016 as Compared to the Year Ended December 31, 2015

Revenues

Total revenues were $31.2 million for the year ended December 31, 2016, $8.4 million higher than total revenues of $22.8 million for the year ended December 31, 2015. Total revenues by revenue component were as follows (dollars in thousands):

		Year Ended December 31,								Increase / (decrease)
		2016				2015				$					%
Investment advisory and incentive fees		$	18,320			$	12,635			$	5,685				45.0	%
Institutional research services			12,634				9,927				2,707				27.3
Other revenues			273				281				(8	)			(2.8	)
Total revenues		$	31,227			$	22,843			$	8,384				36.7	%

Investment advisory and incentive fees: Investment advisory income is directly influenced by the level and mix of average AUM. We earn advisory fees based on the level of average AUM in our products.

Advisory fees were $8.9 million for 2016 compared to $8.4 million for 2015, an increase of $0.5 million. This increase is a result of the increase in average AUM to $1.19 billion in 2016 from $1.07 billion in 2015, an increase of $12 million.

Incentive fees are directly related to the gains generated for our clients. We earn a percentage, usually 20%, of the economic gains of our clients’ AUM. Incentive fees were $9.4 million in 2016, up $5.1 million from $4.3 million in 2015 as market appreciation in our clients’ accounts were higher in 2016 as compared to 2015.

Institutional research services: Institutional research services revenues in 2016 were $12.6 million, a $2.7 million, or 27%, increase from $9.9 million in 2015 resulting from higher brokerage commissions derived from securities transactions executed on an agency basis, sales manager fees earned from at-the market offerings of certain GAMCO closed-end funds and an increase of $1.5 million due to a renegotiation of the research services fee agreements with affiliates.

Other revenues: Other revenues were $0.3 million for 2016 and 2015.

Expenses

Compensation: Compensation costs, which include variable compensation, salaries, bonuses and benefits, were $31.0 million for the year ended December 31, 2016, a 17% increase from $26.4 million for the year ended December 31, 2015. Fixed compensation costs, which include salaries, bonuses and benefits, increased 12% to $19.3 million in 2016 from $17.3 million in 2015 due primarily to an increase in research analyst headcount and additional administrative personnel necessary to support our reporting as a stand-alone public company. The remainder of the compensation expenses represents variable compensation that fluctuates with management fee and incentive fee revenues. For 2016, variable payouts on revenues were $11.7 million, up $2.7 million from the $9.0 million in 2015. Variable payouts are impacted by the mix of products upon which performance fees are earned and the extent to which they may exceed their allocated costs.

Stock-based compensation: Stock-based compensation was $2.5 million in 2016, a decrease of $2.4 million, as compared to $4.9 million in 2015. The decrease was primarily due to the accelerated vesting of restricted stock that occurred in October of 2015.

Management fees: Management fee expense is incentive-based and entirely variable compensation in the amount of 10% of the aggregate pre-tax profits which is paid to Mario J. Gabelli or his designees pursuant to his employment agreements with AC and GAMCO. In 2016 and 2015, AC recorded a management fee expense of $1.6 million and contra-expense of $0.3 million, respectively, as presented in the consolidated statements of income. Note that the management fee expense for the first eleven months of 2015 was determined on a carve-out basis pursuant to Mr. Gabelli’s employment agreement with GAMCO and the management fee expense for the month of December 2015 and full year 2016, post spin-off, was determined based on Mr. Gabelli’s employment agreement with AC. The management fee expense for the month of December 2015 was $0.2 million. Subsequent to the spin-off, management fee expense is determined based on Mr. Gabelli’s employment agreement with AC.

 

Other operating expenses: Our other operating expenses were $8.4 million in 2016 compared to $6.2 million in 2015, an increase of $2.2 million due primarily to our transformation to a stand-alone public company.

Investment and other non-operating income, net

Net gain from investments: Net gain from investments is directly related to the performance of our proprietary capital accounts. For the year ended December 31, 2016, net gains from investments were $19.9 million versus $8.3 million in the prior year primarily due to gains on marking the portfolio to market.

Interest and dividend income: Interest and dividend income increased $8.0 million to $12.7 million in 2016 from $4.7 million in 2015 due to an increase in interest income of $6.9 million from the GAMCO Note and higher dividend income.

Interest expense: Interest expense decreased to $0.6 million in 2016 from $1.3 million in 2015.

Income Taxes

In 2016, we recorded an income tax expense of $3.9 million with the ETR of 27.0%. The ETR is below the standard corporate tax rate of 34% primarily due to the benefits of donated appreciated securities and the dividends received deduction. In 2015, we recorded an income tax benefit of $1.7 million with the ETR of 65.4%. The ETR is unusually high because we have favorable permanent tax differences in the form of the dividends received deduction that increased our tax benefit on this relatively small net loss base.

Noncontrolling Interests

Net income (loss) attributable to noncontrolling interests was $0.3 million in 2016 compared to a loss of $0.8 million in 2015.

Net Income (Loss)

Net income for the year ended December 31, 2016 was $10.2 million versus net loss of $0.1 million for the year ended December 31, 2015 substantially the result of increased net gains from investments, interest income from the GAMCO Note, and incentive fees partially offset by the $5.4 million cost of AC’s initial Shareholder Designated Charitable Contribution Program and increased operating expenses resulting from our transformation to a stand-alone public company.

Liquidity and Capital Resources

Our principal assets consist of cash and cash equivalents; short-term treasury securities; marketable securities, primarily equities, including 4.4 million shares of GAMCO stock; and interests in affiliated and third party funds and partnerships. Although Investment Partnerships are subject to restrictions as to the timing of distributions, the underlying investments of such Investment Partnerships are, for the most part, liquid, and the valuations of these products reflect that underlying liquidity.

 

Summary cash flow data is as follows (in thousands):

 

 

We require relatively low levels of capital expenditures and have a highly variable cost structure where costs increase and decrease based on the level of revenues we receive. Our revenues, in turn, are highly correlated to the level of AUM and to their investment performance. We anticipate that our available liquid assets should be sufficient to meet our cash requirements as we build out our operating businesses. At December 31, 2017, we had cash and cash equivalents of $293.1 million and $638.4 million of investments net of securities sold, not yet purchased of $5.7 million. Of these amounts, $5.1 million and $30.0 million, respectively, were held by consolidated investment funds and may not be readily available for the Company to access.

Net cash used in operating activities was $67.6 million for 2017. In 2017, our sources of cash included $8.7 million of net income increased by (a) non-cash stock-based compensation and charitable contributions of $8.5 million and (b) net unrealized losses attributable to available for sale securities of $7.4 million, and reduced by (c) non-cash equity earnings of partnerships and deferred taxes of $10.3 million and $3.2 million, respectively. Net cash uses included $5.1 million of net contributions to partnerships, $26.2 million for increases in trading securities and a net reduction in liabilities of $47.3 million

Net cash provided by operating activities was $6.6 million for 2016. In 2016, our sources of cash included a $43.2 million decrease in receivable from brokers, increased accrued expenses and other liabilities of $32.0 million, $23.2 million of decreases in distributions from partnerships, net income of $10.5 million, $6.8 million from an increase in compensation payable, a $5.9 million decline in receivable from affiliates and $2.5 million of stock-based compensation expense. Cash uses included $48.2 million decrease in payable to brokers, $36.4 million of contributions to partnerships, $13.8 million of increases in trading securities, $11.2 million of equity in net gains from partnerships, a $5.5 million increase in other assets, and an increase in investment advisory fees receivable of $4.9 million.

Net cash used in operating activities was $47.4 million. In 2015, our sources of cash included $44.5 million increase in payable to brokers, $22.9 million of distributions from partnerships, a $10.5 million decrease in other assets and $1.7 million from an increase in compensation payable. Cash uses included $71.6 million of increases in trading securities, a $30.0 million increase in receivable from brokers, $15.2 million of contributions to partnerships, a $4.7 million decline in payable to affiliates and a $4.3 million decline for income taxes payables and deferred tax liabilities.

Net cash used in investing activities of $18.7 million in 2017 is due to purchases of the GBL 1.6% Note (due February 28, 2018) and available for sale securities totaling $19.9 million less $0.3 million in proceeds from sales of available for sale securities and $0.9 million from return of capital from available for sale securities. Net cash used in investing activities of $4.1 million in 2016 is due to purchases of available for sale securities of $5.1 million less $0.8 million in proceeds from sales of available for sale securities and $0.2 million from return of capital from available for sale securities. Net cash used in investing activities of $41.7 million in 2015 is due to purchases of available for sale securities of $43.3 million less $1.0 million in proceeds from sales of available for sale securities and $0.5 million from return of capital from available for sale securities.

 

Net cash provided by financing activities was $65.4 million for 2017, largely resulting from the $50.0 million prepayment of the GAMCO Note and contributions from redeemable noncontrolling interests of $41.6 million partially offset by $21.2 million of treasury stock purchases and dividend payments of $4.8 million. Net cash provided by financing activities was $105.9 million for 2016, largely resulting from $150 million of proceeds from payment of the GAMCO Note partially offset by $41.6 million of treasury stock purchases. Net cash provided by financing activities was $9.3 million for 2015, largely resulting from $25.2 million in cash transfers from GAMCO less $16.0 million repayment of the GAMCO demand loan.

G.research is registered with the SEC as a broker-dealer and is regulated by FINRA. As such, G.research is subject to the minimum net capital requirements promulgated by the SEC. G.research’s net capital exceeded these minimum requirements at December 31, 2017. G.research computes its net capital under the alternative method permitted by the SEC, which requires minimum net capital of the greater of $250,000 or 2% of the aggregate debit items in the reserve formula for those broker-dealers subject to Rule 15c3-3 promulgated under the Exchange Act. As of December 31, 2017, and 2016, G.research had net capital, as defined, of approximately $41.8 million and $3.7 million, respectively, exceeding the regulatory requirement by approximately $41.6 million and $3.4 million, respectively. Net capital requirements for G.research may increase in accordance with rules and regulations to the extent it engages in other business activities.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements.

Contractual Obligations

The following table sets forth our significant contractual cash obligations as of December 31, 2017 (in thousands):

 

 

Critical Accounting Policies

In the ordinary course of business, we make a number of estimates and assumptions relating to the reporting of results of operations and financial condition in the preparation of our consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”). We base our estimates on historical experience, when available, and on other various assumptions that are believed to be reasonable under the circumstances. Actual results could differ significantly from those estimates under different assumptions and conditions.

We believe the critical assumptions and estimates are those applied to revenue recognition, the accounting for and valuation of investments in securities, partnerships, and offshore funds, income taxes, and stock-based compensation accounting.

Revenue Recognition

The Company’s revenues are derived primarily from investment advisory and incentive fees and institutional research services.

Investment advisory and incentive fees are directly influenced by the level and mix of AUM as fees are derived from a contractually-determined percentage of AUM for each account as well as incentive fees earned on the investment performance of certain accounts. Management fees from investment partnerships and offshore funds are computed either monthly or quarterly, and amounts receivable are included in investment advisory fees receivable on the consolidated statements of financial condition. These revenues vary depending upon the level of capital flows, financial market conditions, investment performance and the fee rates applicable to each account.

 

Revenues from Investment Partnerships and separate accounts also generally include an incentive allocation or fee on the absolute gain in a portfolio or a fee of 20% of the economic profit as defined in the partnership agreement. The incentive allocation or fee is generally recognized at the end of an annual measurement period and amounts receivable are included in investment advisory fees receivable on the consolidated statements of financial condition.

G.research, LLC provides institutional research services and earns brokerage commission revenues and sales manager fees on a trade-date basis from securities transactions executed on an agency basis on behalf of institutional clients and mutual funds, private wealth management clients and retail customers of affiliated companies. It has also been involved in syndicated underwriting activities that included public equity and debt offerings managed by major investment banks. Underwriting fees include gains, losses, selling concessions and fees, net of syndicate expenses, arising from securities offerings in which G.research acts as underwriter or agent and are accrued as earned. G.research also provides institutional investors and investment partnerships with investment ideas on numerous industries and special situations, with a particular focus on small-cap and mid-cap companies. Commission revenue and related clearing charges are recorded on a trade-date basis and are included in institutional research services and other operating expenses, respectively, on the consolidated statements of income.

Finally, AC also has investment gains or losses generated from its proprietary trading activities which are included in net gain from investments on the consolidated statements of income.

Investments in Securities Transactions

Investments in securities are accounted for as either “trading securities” or “available for sale” and are stated at fair value. Management determines the appropriate classification of debt and equity securities at the time of purchase and reevaluates such designations as of each balance sheet date. U.S. Treasury Bills and Notes with maturities of greater than three months at the time of purchase are considered investments in securities. Securities that are not readily marketable are stated at their estimated fair values in accordance with GAAP. A substantial portion of investments in securities are held for resale in anticipation of short-term market movements and therefore are classified as trading securities. Trading securities are stated at fair value, with any unrealized gains or losses reported in current period earnings in net gain from investments on the consolidated statements of income. AFS investments are stated at fair value, with any unrealized gains or losses, net of taxes, reported as a component of other comprehensive income/(loss) on the consolidated statements of comprehensive income/(loss) except for losses deemed to be other than temporary which are recorded as realized losses on the consolidated statements of income. Securities transactions and any related gains and losses are recorded on a trade date basis. Realized gains and losses from securities transactions are computed using the specific identified cost basis and are included in net gain from investments on the consolidated statements of income.

AFS securities are evaluated for other than temporary impairment each reporting period and any impairment charges are recorded in net gain from investments on the consolidated statements of income. Management reviews all available for sale securities whose cost exceeds their fair value to determine if the impairment is other than temporary. Management uses qualitative factors such as diversification of the investment, the intent to hold the investment, the amount of time that the investment has been impaired and the severity of the decline in determining whether the impairment is other than temporary.

Securities sold, but not yet purchased are recorded on the trade date, and are stated at fair value and represent obligations of AC to purchase the securities at prevailing market prices. Therefore, the future satisfaction of such obligations may be for an amount greater or less than the amounts recorded on the consolidated statements of financial condition. The ultimate gains or losses recognized are dependent upon the prices at which these securities are purchased to settle the obligations under the sales commitments. Unrealized gains and losses and realized gains and losses from covers of securities sold, not yet purchased transactions are included in net gain from investments on the consolidated statements of income.

Consolidation

The Company assesses all entities with which it is involved for consolidation on a case by case basis depending on the specific facts and circumstances surrounding each entity. Pursuant to accounting guidance, the Company first evaluates whether it holds a variable interest in an entity. The Company factors in all economic interests including proportionate interests through related parties, to determine if such interests are to be considered a variable interest. For entities where the Company has determined that it does hold a variable interest, the Company performs an assessment to determine whether each of those entities qualify as a variable interest entity (a “VIE”).

 

The determination as to whether an entity qualifies as a VIE depends on the facts and circumstances surrounding each entity. The granting of substantive kick-out rights is a key consideration in determining whether a limited partnership or similar entity is a VIE and whether or not that entity should be consolidated. The Company does not consolidate those VIEs in which substantive kick-out rights have been granted to the unaffiliated investors to either dissolve the fund or remove the general partner.

Under the variable interest model, the Company consolidates those entities where it is determined that the Company is the primary beneficiary of the entity. The Company is determined to be the primary beneficiary if it holds a controlling financial interest in the VIE defined as possessing both (i) the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and (ii) the obligation to absorb losses of the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE. If the Company alone is not considered to have a controlling financial interest in the VIE but the Company and its related parties under common control in the aggregate have a controlling financial interest in the VIE, the Company will still be deemed to be the primary beneficiary if it is the party within the related party group that is most closely associated with the VIE. If the Company and its related parties not under common control in the aggregate have a controlling financial interest in a VIE, then the Company is deemed to be the primary beneficiary if substantially all the activities of the entity are performed on behalf of the Company. The Company determines whether it is the primary beneficiary of a VIE at the time it becomes initially involved with the VIE and reconsiders that conclusion continuously. Investments and redemptions (either by the Company, related parties of the Company or third parties) or amendments to the governing documents of the respective entity may affect an entity’s status as a VIE or the determination of the primary beneficiary.

Under the voting interest model, the Company consolidates those entities it controls through a majority voting interest or other means.

Equity Method Investments. Substantially all of AC’s equity method investees are entities that record their underlying investments at fair value. Therefore, under the equity method of accounting, AC’s share of the investee’s underlying net income predominantly represents fair value adjustments in the investments held by the equity method investees. AC’s share of the investee’s underlying net income or loss is based upon the most currently available information and is recorded as net gain from investments on the consolidated statements of income. Capital contributions are recorded as an increase in investments when paid, and withdrawals and distributions are recorded as reductions of the investments when received. Depending on the terms of the investment, the Company may be restricted as to the timing and amounts of withdrawals.

See Note D. Investment Partnerships and Variable Interest Entities for more detail as to the number and types of entities consolidated as well as the impact on the consolidated statements of financial condition and consolidated statements of income.

Investments in Partnerships and Affiliates

The Company is general partner or co-general partner of various affiliated entities. We also have investments in unaffiliated partnerships, offshore funds and other entities (“unaffiliated entities”). Given that we are not a general partner or investment manager in any unaffiliated entities, we do not (a) earn any management or incentive fees: (b) have a controlling financial interest; and (c) currently consolidate any unaffiliated entities.

Our balance sheet caption “Investments in partnerships” includes investments in both affiliated and unaffiliated entities which the Company accounts for under the equity method of accounting and certain investments that the Company accounts for at fair value.

The Company records noncontrolling interests in consolidated Investment Partnerships for which the Company’s ownership is less than 100%.

 

Income Taxes

Deferred tax assets and liabilities are recorded for temporary differences between the tax basis of assets and liabilities and the reported amounts on the consolidated financial statements using the statutory tax rates in effect for the year when the reported amount of the asset or liability is recovered or settled, respectively. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date. A valuation allowance is recorded to reduce the carrying values of deferred tax assets to the amount that is more likely than not to be realized. For each tax position taken or expected to be taken in a tax return, the Company determines whether it is more likely than not that the position will be sustained upon examination based on the technical merits of the position, including resolution of any related appeals or litigation. A tax position that meets the more likely than not recognition threshold is measured to determine the amount of benefit to recognize. The tax position is measured at the largest amount of benefit that is greater than 50% likely of being realized upon settlement. The Company recognizes the accrual of interest on uncertain tax positions and penalties in income tax provision on the consolidated statements of income.

Stock-Based Compensation

In connection with the Spin-off, the Company granted RSAs to staff members which were recommended by the Company’s Executive Chairman, who did not receive an RSA or option award, and approved by the Compensation Committee of GAMCO’s Board of Directors. We use a fair value based method of accounting for stock-based compensation provided to our employees. The estimated fair value of RSAs is determined by using the closing price of the relevant stock on the day prior to the grant date. The value of the RSAs, net of estimated forfeitures, is recognized as expense over the respective vesting period for these awards which is either (1) five years (30% three years and 70% five years from the date of grant, respectively), or (2) ten years (30% three years and 10% each year thereafter from the date of grant, respectively). The forfeiture rate is determined by reviewing historical forfeiture rates for previous stock-based compensation grants and is reviewed and updated quarterly, if necessary. During the vesting period, dividends to RSA holders are held for them until the RSA vesting dates and are forfeited if the grantee is no longer employed by the Company on the vesting dates. Dividends declared on these RSAs, less estimated forfeitures, are charged to retained earnings on the declaration date. In connection with the spin-off of the Company from GAMCO, any GAMCO employee (including GAMCO employees who became AC employees) who had GAMCO RSAs were granted an equal number of AC RSAs so that the total value of the RSAs post-spin was equivalent to the total value pre-spin. In accordance with GAAP, we have allocated the stock compensation costs between GAMCO and AC based upon each employee’s individual allocation of their responsibilities between GAMCO and AC. As of June 15, 2017, all the AC RSAs issued under our Stock Compensation Plan were accelerated and are no longer outstanding.

Recent Accounting Developments

See Footnote B. Significant Accounting Policies – Recent Accounting Developments.

Seasonality and Inflation

We do not believe our operations are subject to significant seasonal fluctuations. We do not believe inflation will significantly affect our compensation costs, as they are substantially variable in nature. However, the rate of inflation may affect our expenses such as information technology and occupancy costs. To the extent inflation results in rising interest rates and has other effects upon the securities markets, it may adversely affect our financial position and results of operations by reducing our AUM, revenues or otherwise.

ITEM 7A:

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

In the normal course of its business, AC is exposed to risk of loss due to fluctuations in the securities market and general economy. Management is responsible for identifying, assessing and managing market and other risks.

 

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See accompanying notes.

 

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