DHIL - NASDAQ

Welcome to the Diamond Hill First Quarter 2017 Equity Portfolio Manager Conference Call. My name is Adrian and I’ll be your operator for today’s call. At this time all participants are in listen-only mode. Later, we’ll conduct a question and answer session. Please note this conference is being recorded. I’ll now turn the call over to Kristen Sheffield. Kristen Sheffield you may begin.

Thank you, Adrian. Good afternoon everyone and welcome to the Diamond Hill first quarter equity portfolio manager conference call. Thank you for joining us this afternoon. My name is Kristen Sheffield and I'll be moderating today's call. We will begin our call today with some timely comments from one of our healthcare sector Research Analyst, Kyle Schneider on the current political environment and the potential impacts of healthcare reform on our current portfolio holdings. After Kyle's remarks, each of our equity portfolio managers will provide commentary on their respective strategies before going to Q&A. As a reminder, we will host a separate fixed income portfolio manager call tomorrow at 2 o'clock P.M. Eastern Time. Download information is available on the home page of our website and we hope you will join us. When we are ready for the Q&A session, the operator will provide instructions if you want to ask a question over the phone. You can also type a question on your screen at any time throughout the call and we'll be sure to address it at the end of the call. As always we have a few important compliance statements to go over before we begin. The opinions expressed by portfolio managers are their own and are subject to change at any time as circumstances change. Any discussion of specific portfolio holdings will be as of March 31, 2017. Portfolio holdings are subject to change without notice. And finally, a complete list of portfolio holdings as of March 31, 2017 is available on our website. This next slide provides additional important disclosures. We encourage you to read these carefully at a later time. I will now hand the call over to Kyle Schneider. Kyle?

Thanks Kristen. I’ll recap some of the effects of Obamacare, discuss the path forward, and what it means for a hospital managed care device investments. To give some context, Obamacare lowered the number of uninsured by about 20 million. 15 million obtained insurance through Medicaid, another 5 million via the public exchanges. There's 10 million total in the public exchanges, so half previously like a coverage. The takeaway here is that the overall market is still dominated by those who obtain insurance through an employer which is relatively unaffected by the current political discussion. Following the failure of the American Health Care Act, the question is what's next. There are three options. First the GOP could push for another comprehensive bill. This would require a lot of time to deploy capital and might produce nothing. Option two is that they can strip federal funding for the exchanges. The president has threatened this as a bargaining chip, but Democrats would probably be happy to call as bluff heading into mid-term elections. Then there is option three, the most likely. Congress could evolve a benefit design back down to the state level. This probably looks a lot like the current system with some variations between the liberal and conservative states. In terms of the impacts, I’ll start with the hospitals. We owned LifePoint Health, rural hospital system I've written about in the past. While they benefited from Medicaid expansion and lower levels of bad debt write offs, there's very little exposure to the exchanges. It’s known that rural hospitals are under pressure and many are located in key trunk states. On this basis, it's possible Medicaid cuts could hit earnings a bit, but it's very unlikely there will be relief funding as an offset. Additionally, new states such as Northern Carolina are looking to expand Medicaid. In aggregate, these factors probably wash - limited the impact to about 5% of earnings. Next managed care. We owned Aetna, a diversified insurer which suffered heavy losses in the exchanges. It actually did most of its exchange business, but would benefit from the permanent revocation of the industry tax levied under Obamacare. This impact is fairly minimal and likely under 5% of earnings. For other holding, UM is being acquired by WellCare in an all-cash deal which we closed shortly. I would note that both managed care and hospitals are highly taxed entities with rates in the mid to high 30s even excluding Obamacare related taxes. If prior corporate tax reform does occur, we would be obvious beneficiaries. Finally devices, where most of our capital in this sector is invested. Devices were hit with a 2.3% tax in US revenues under Obamacare which has since been suspended. In my opinion, it's unlikely to be restored given that’s unpopular on both sides of the aisle. The impact various depending upon the company, but the tax represents about 5% of earnings at the high end. There were also some modest benefits from those obtaining insurance coverage for nothing overly material. Generally, these are well diversified companies which further mitigates the impact. We believe it would business as usual for the group. Will that I’ll turn it back over Kristen.

Thank you, Kyle. We will now turn to our equity strategy updates beginning with the small cap strategy. Tom?

Thanks Kristen. The Diamond Hill small cap fund increased 0.86% in the first quarter of 2017 trailing a 2.46% increase in the Russell 2000 Index and ahead of the negative 0.13% return of the Russell 2000 Value Index. Healthcare was by far the best performing sector in the Russell 2000 Index and a relatively small exposure to the sector in the fund created a relative drag for the fund even though the securities that the fund owns in the healthcare sector performed comparably to those in the index. Energy and financials were both negative in the quarter, a reversal from the fourth quarter of 2016 and helping to explain the divergence between the Russell 2000 Value Index and the Russell 2000 Growth Index. The contribution from each of those sectors in the fund was very similar to that of the Index. There was one announced deal in the financial sector Fortress Investment Group which agreed to be bought by Soft Bank at a significant premium to the then share price albeit slightly below our estimate of intrinsic value. Encouragingly, both Live Nation and DST Systems, two companies that lagged meaningfully in 2016 despite what I felt were business results in line with my expectations were both up more than 14% in the quarter. And Vail Resorts, a meaningful outperformer continued to do so in Q1 as it made yet another acquisition this time in Stowe, Vermont. The biggest attractor in Q1 performance was Avis Budget, still our largest holding and down nearly 20% in the quarter. When reporting its fourth quarter, the company citing industry over fleeting reported Americas pricing down 1%, a reversal of the positive inflection the company had reported in the quarter - in the second and third quarters of 2016 after many quarters of flat to declining prices. The company also commented that pricing would be down in Q1 as it takes some time for over fleeting to be corrected. And offering 2017 guidance, the company forecasts a fairly wide range of adjusted EBITDA between 840 million and 920 million and adjusted EPS between $3.05 and $3.75. Importantly, the company used an assumption for used car prices to be down 3% and for the company to do slightly better than this because it uses alternative disposition channels and generally sells cars younger than what the typical used car that's sold. The market appears quite concerned about used car prices as widely reported indices from the National Automobile Dealers Association and Manheim, a used car auctioneer are tracking worse than this down 3% assumption. While declines in residual values create risk to the fundamentals, the industry would likely react to negative developments by reducing fleet trying to create an environment where price increase is to be taken and offset any cost pressures. The second and third quarters are the most important in terms of earnings for the industry and it appears that Hertz [ph] would be most under pressured to de-fleet as its EBITDA has been under pressure, which has been increasing its leverage ratios. Importantly, the company forecasts 2017 free cash flow to be again above 450 million, the fifth consecutive year for that to occur. The company is dedicating more than 80% of free cash flow to share buybacks having bought back $390 million in 2016 and expecting to repurchase at least 300 million in 2017. Even adjusting downward for a few items, our free cash flow yield still remains in the mid to high teens, so we're still optimistic that we can grind out a return even with some negative developments from used car prices in the near term. Looking at new holdings, really just three, Validus Holdings is a Bermuda-based reinsurer with a decent history of accounting book value in the low-double digits. It has expanded its specialty insurance lines and asset management as competition in traditional reinsurance markets has intensified. WNS Holdings is a business process company with a lot of employees based internationally. And CubeSmart is a storage company which we found to be a pretty attractive area with REITs. Two eliminated positions, Endurance Specialty Holdings, it was bought by Sompo of Japan and that deal closed during the first quarter. And then Radian, we got only partial of the original position we intended to buy. The company as a mortgage insurer saw its price increase quite a bit and we finally exited the position. Colony Capital is just - as they did a three way merger, Colony Capital became Colony NorthStar, so no real change in the position just a change as a result of M&A activity. With that I'll turn it back to Kristen.

Thank you, Tom. Next Chris Welch will provide comments on the small-mid caps and mid-cap strategy results. Chris?

Thanks Kristen, the small-mid cap fund returned 2.5% in the first quarter that trailed the benchmark Russell 2500 Index by more than 100 basis points. We remain ahead of the benchmark by more than 150 basis points annually over five years and by about 100 basis points ahead since inception, which is now eleven and a quarter years. The negative drivers in the first quarter were unfavorable stock selection and the financials in technology sectors, and also holding high-single digit level of cash in the rising market was a headwind and that was partially offset by favorable selection in the materials sector. Looking at the sector allocations, no major changes to the sector weights. On a quarterly basis, the cash level I mentioned at 9.5% that's about as high as it's been in the past five years. And then looking at the portfolio statistics and new names continue to see low turnover, 16% turnover over the past 12 months. We just added one new active name portfolio during the quarter, Validus Holdings which Tom mentioned, the Bermuda insurer - reinsurer, the Colony NorthStar as Tom referred to just came through a merger from our existing colony capital position. On the sales side, again as Tom referred to the Endurance Specialty Holdings that acquisition was completed and so we received cash for those shares, a good portion of which we reinvested in Validus, which is a similar business. And then the Linear Technology shares that we owned, they were also - that acquisition was completed, Analog Devices bought that company, received about a quarter of the purchase price for that acquisition in Analog Devices shares and then we turned around and sold those shares feeling that they were fully valued. And then Anixter is a stock that we had invested in a year or two ago. It has done well for us, it was approaching its intrinsic value estimate and so we eliminated that position from the portfolio. And then just kind of high level thoughts on the portfolio, generally speaking valuations remain high for small and mid-cap stocks. In many cases it requires aggressive assumptions to justify the valuations of some of the stocks in these areas. We maintain high-single digit cash level. We have been able to put together a portfolio of 55 to 60 stocks that we believe are still attractive. But as you can see from the small number of new additions to the portfolio in recent quarters it's been a bit more challenging to find a lot of attractive new ideas, but we really like the ones that we are finding. Then just turning on to the mid cap fund. The return for the quarter was 2.9% which trailed the benchmark Russell Midcap Index by more than 200 basis points, similar drivers to this mid-fund in terms of kind of sector impacts relative to the benchmark over the since inception period, which is now three and a quarter years we're slightly ahead of the benchmark. Nothing really to add on the sector allocation for mid-cap, also have high-single digit cash there. And then looking at the new and eliminated positions. Same as mid, the one exception is Cisco, the food distributor, which rose to our estimate of intrinsic value following some positive actions they took post the denial of their merger with US Foods. They engaged in some cost cutting and share repurchases which created some value for the company and as that company hit its estimate of intrinsic value we exited the position in the quarter. With that I will turn it back around to Kristen.

Thanks, Chris. Chuck Bath will now provide comments on the large cap strategy. Chuck?

Thanks, Kristen. For the first quarter of 2017, the fund was up 6.34% versus the benchmark 6.03%. So we were happy with that performance. And then our longer term performance numbers are also shown there and certainly very happy with and since inception [indiscernible] June of 2001, most of which have been the portfolio managed there, we're happy with the performance now that it goes back sixteen years. So we always try to think long term and focus on long-term performance, so we're happy with what has been accomplished so far. In terms of the portfolio itself and the performance, it's interesting and sometimes what drives the performance will be not what you own but maybe what you don't own. In this case, energy was very weak in the quarter and we have reduced our energy exposure meaningfully last year, if you will recall, energy was a very strong sector and my mind drove many of the valuations to levels which are not sustainable, including one of the names which we owned, which was EOG. That name was eliminated from the portfolio and therefore our energy weightings went down even further, about [indiscernible] I would want to take just over 2%. I don’t want to have zero exposure to the highly volatile and fairly unpredictable sector. So what drove my concern was not just the stock price appreciation but stocks starting to discount. In our opinion, oil prices and gas prices are higher than were justified and higher than they were in the market currently. So EOG was the name we eliminated from the portfolio. The other name which is eliminated was United Parcel Service. The company was accelerating its capital spending at a time when returns on capital were going down, a sign that increasing competitive pressure were forcing them to invest in lower return businesses and it just struck us that it was a deteriorating situation not one that was going to work out well in the long term, so we reduced, excuse me, we didn’t reduce, we eliminated the position. And then finally more pleasantly, I guess, Progressive Corp reached our estimate of intrinsic value, we sold the net position in the portfolio, used some of the proceeds to invest in other financial services companies within the portfolio and added a new name, Berkshire Hathaway which is a financial service conglomerate as a new holding and the only new holding for the portfolio You'll see the financial services portfolio that has been for several quarters now is the largest weighting in the portfolio and it’s that, it’s that way for a reason I continue to find that sector to be the least expensive and riding the most opportunity in a market which we can all proceed, it’s certainly it’s not expensive, it’s certainly isn't as cheap as it used to be. And so that is the area where I've continued to find value and it's an area where, as I was exiting Progressive, I looked for other financial names to replace that position. Cash is around 2% of the portfolio, sort of pretty low, but up against a little bit year-over-year but that's okay. And beyond that for the most part, not meaningful portfolio turnover, the trailing turnover of 23%. It’s about normal for the portfolio, yes maybe a little bit, we've been close to 20% for several quarters now and that over the long term I think you'll find that is where the portfolio turnovers seem to settle in and 49 names in the portfolio again very similar to the way it’s been in the past. For the most part, you see the positioning portfolio should not change that much, the change has been more evolutionary, but I’d like to say revolutionary, but it reflects where we see the best opportunities in the portfolio. I think I’ll conclude my comments there and give the microphone back to Kristen and I’ll be available for any questions if we have some later.

Thank you Chuck. Next Rick Snowdon will give us an update on our all cap select strategy. You will notice that effective February 28, we added all cap to the strategy name. We believe modifying the name better reflects the strategies ability to invest across the market cap spectrum. Importantly, there is no change to the strategy’s investment philosophy or process. Rick?

Thanks Kristen. In the first quarter, the all cap select fund was up 5% whereas the benchmark was up a bit more at 5.75%. However if you look at the last 12 months as a whole, the fund has had a nice recovery outpacing the benchmark by 2.5%. Some of our worst performing names for the quarter were Avis which Tom already discussed. Another one was NationStar, it was off 13% in the quarter largely based on concerns that higher rates will hurt their originations business. This however misses the fact that higher rates also reduce prepayments, extending life of NationStar’s cash generating assets. There's also a concern that the mix shift to sub servicing rights from mortgage servicing rights will generate less revenue and profit. However the shift is also to benefit - to offset and benefits I should say, the cost - one, the cost required to provide subservicing or lower and subservicing is infinitely more capital efficient as a company does not have to buy the servicing rights, freeing up capital for other uses including share repurchases and debt repayment. Red Rock Resorts is a new holding which had a tough first quarter and the portfolio. Red Rock is a regional casino operator, which has dominant market share in Las Vegas locals markets. I think about people that live in Las Vegas, they're not necessarily going to go to the Strip, go to the Bellagio or whatever they're going to go to some place that’s near supermarket or on their way home, so sort of a more casual environment. This company does a great job of using the rewards program to market to and lock in this customer base. The business is also somewhat protected from new competition as the area is supply controlled in terms of the possibility of new casinos especially in areas where the local casinos are located. The quarter was a bit messy due to a recent acquisition, some facility upgrades, change in restaurant formats and a bad run for sports books in general that's across all the casinos relating to the outcomes of some sporting events in the fourth quarter. We think these issues are all transitory in nature and we'd like to protect the nature of the business as well as the returns on incremental invested capital. So a little bit on the rosary side or better names in the quarter included Fox, which was up 17% a quarter. There wasn't really much news other than putting up a big quarter, since the quarter, it’s given some of those gains back probably due to concerns about the sexual misconduct claims against Bill O'Reilly who hosts a popular show on Fox News. Although these claims are very serious in nature, we don't believe that the likely corrective measures will have a significant impact on the profitability of the company at large. We see Fox as a very valuable platform for the creation and distribution of dramatic and sports programming both in the current and future versions of content consumption because we certainly know those are all changing. We also think the current profitability is understated due to current investments in sports rights, the benefit of which have yet to flow through fully to the financial statements. NVR also had a good quarter, it was up 26%. NVR is a high-quality home builder, it had strong performance across the board, revenue, earnings, new orders, backlog, growth and inventory turnover. We think there's a fairly long run away for home builders due to the under building for so many years after their financial housing crises. And we especially like NVR due to their very conservative balance sheet and low risk manner of securing land. Just couple more real quick, Liberty Global was up 17% on a good quarter and acquisition rumors with regard to Vodafone, potentially being interested in acquiring Liberty. They also upped their share repurchase and despite some bumps in the road appear to be on track with their network expansion in the UK. Finally, Apple was up 25% in the quarter. Based on a good earnings call, owning to the good sales to the iPhone 7, but mostly due to expectations that the iPhone 8 which is expected this fall will offer a greater level of innovation and a lot of customers have actually held off upgrading. So even though iPhone 7 did well, the expectation is a lot of people held off upgrading due to these thoughts about iPhone 8. So there's been [indiscernible] pent up demand for iPhone 8. During the quarter, we eliminated two names, Allergan and Cody. The elimination of Allergan was due to increasing concerns about hits to their intrinsic value due to pricing pressure and competition to several of their legacy products as well as concerns about the R&D costs of plugging those holes going forward. Cody’s elimination was due to poor performance, which also eroded our belief in the value of its intrinsic value. New names included Red Rocks, which I already mentioned, Pepsi, which we think is a high quality company at a reasonable price. They've got issues in their legacy soda business, but have done a good job of diversifying away from that business with its products while also leveraging their extremely valuable snack business and delivery network. Aetna we bought after the Humana merger was called off. We think the managed care companies will be pivotal in controlling health care spend going forward and we’ll be well compensated for this. And then we also bought CubeSmart, which Tom already discussed a little bit. So I’ll probably stop there. Thanks, Kristen.

Thank you. Next, Chris Bingaman, Portfolio Manager of our Long-Short Strategy will provide an update on recent results.

Thanks, Kristen. Long-short fund in the quarter was, I shares were up 2.87% versus the blended 60-40 Russell 1000 index of 3.64%. So trail by 75, 80 basis points over five years on those measures. The fund is ahead of the blended benchmark by about 60 basis points. The biggest explanatory factors in the quarter were modest allocation in tacking a heavy financial services waiting. Those were the big drags in the quarter, while as Chuck mentioned, modest energy waiting and some short exposure in the financials were the positives. On page 33 and just in terms of sector allocation, nothing real new here. This has been sort of stable for the last two, three quarters in terms of sectors, so those same top five sectors from financials down to industrials, that’s sort of been there for like I said a number of quarters. Not a lot of change there. As Chuck mentioned, not a lot of energy exposure and still having a little bit of a difficult time finding ideas and undervalued situations and staples. So not a lot of change there. On page 34, in terms of new and eliminated, a fair amount of activity, especially in the short side of the book in the quarter. In terms of new positions, Children's Place is new to the fund. CRI and Grand Canyon, we've both been in those in the past, successfully shorted and covered those. Prices came back up. So we took the opportunity to sort of re-short those, re-establish those positions. Children's Place is new. The company, retailer had a relatively good ‘16 compared to a lot of other companies. Traffic trend, same-store sales, a little bit better than what we're seeing in lots of other situations, however ‘17 guidance is fairly modest and it looks like the outlook for both revenue and profit growth is much more difficult. The company has done a nice job in the past few years also on the expense side. So it sure seems like the outlook is just like it's much more difficult and the company share price and valuation performed very well last year. Again, they had relatively good ‘16 to take advantage of that established position during the quarter. In terms of eliminated positions, I'll just sort of bucket these into to the shorts anyway into three categories. So ones that were nicely profitable, American Eagle, Southwestern Energy and Lululemon for the second time were all nicely profitable. Shorts for us, import Bemis and Coke were sort of in that what we call like Alpha shorts performed relatively well for us as shorts didn't make a lot of money them. They were sort of breakeven to modestly profitable during a period of time where the market was up. And then Mobileye, Mobileye, the clear outlier, very poor position for us. On the short side, clearly underestimated their willingness to do a strategic transaction and they were sold during the quarter at a very big premium to Intel. So that’s it on the short side. Longs, EOG, Chuck mentioned IBM had a very good quarter from a price appreciation perspective. We took the opportunity to eliminate the rest of the position. So overall sort of a tough quarter to make money in the short side, relatively pleased the short book was up less than the Russell and less than long portfolio. And finally and just in terms of positioning, we've been below our 60% blended average for the last couple of quarters. That continued last quarter, on page 36, you can see, we finished the quarter at about 54% net and gross exposure under 110. Both of those again sort of trending down over the last couple of quarters as the areas that we really like, we still do, but just a little bit less compelling than they were a year ago. And with that, I’ll turn it back to Kristen.

Thank you. Next, we'll hear from Jason Downey with Review of our research opportunities strategy. Jason.

Thank you, Kristen. The Diamond Hill Research Opportunities Fund Class I Shares increased 4.4% during the quarter, trailing to 5.7% gain for the Russell 3000 Index, while slightly ahead of the 4.3% increase for our blended secondary benchmark. Our trailing five year return is 8.9%, which trails the 13.2% return for the Russell 3000 and 9.9% increase in the blended benchmark. During the quarter, our long book was roughly in line with the Russell 3000, while our short positions trailed the benchmark by over 150 basis points. The largest positive contributors to performance were long investments within the information technology sector. The most meaningful contributor within the sector was Fortinet, which increased 27% during the quarter as it reported a strong quarter and issued encouraging 2017 revenue guidance. The largest detractors to performance were long positions in the telecommunications sector and short positions within Consumer Discretionary. Cincinnati Bell declined 21% during the quarter as they issued disappointing EBITDA guidance for 2017. We continue to expect cash flow to steadily increase over the next five years as a result of investments the company has made over the last several years. Short position Best Buy increased 16% during the quarter, as they reported better than expected fourth quarter results, largely due to better expense management. However, more important from our longer term view is that same-store sales turned negative with negative traffic and the secular headwinds remain in the business. Slide 39 shows our year-over-year changes in industry exposure. You can see the largest increase year-over-year is long exposure in the material sector and this is largely due to long position Axalta which we've added to over the course of the last year and is now one of our larger investments. The largest year over year reductions of exposure came from long positions in the healthcare and IT sectors. In slide 40, you can see that there are more eliminations in new positions on both the long and short sides of the portfolio. Generally, the eliminations were stock prices approaching our intrinsic value estimates or redeploying capital to more attractive opportunities. An exception to this was our short position in Mobileye, which Chris has already discussed. With regards to new positions, on the long side, I’ll highlight Sensata, since it’s unique to the research fund. Sensata is a manufacturer of sensors and controls for automotive and industrial applications. The company is well run with strong margins and returns on capital and we think the market's underestimating the long term margin profile of the business as well as its long term earnings. Chris has already discussed the two new short positions and so I’ll move on to high level thoughts in the portfolio. Portfolio concentration remains high with our top 10 holdings representing about 39% of net assets. The level of concentration has remained fairly consistent since the middle of 2014, however, both our net and gross exposure declined for the second straight quarter. After peaking close to our maximum gross exposure of 140% last fall, our gross exposure is now just under 124%. On this call six months ago, I mentioned we were finding many attractive opportunities under the long and short side of the portfolio pushing our total exposure towards a maximum level with net exposure above our historic average. With the overall market up around 10% between September of last year and March of this year, the opportunity set on the long side isn't quite as attractive as it was last fall and as a result, our long exposure has declined more than our short exposure, bringing net down to 76%, which is closer to our long term average. And with that, I’ll send it back to you Kristen.

Thanks, Jason. To wrap up, Austin Hawley will give us an update on the financial long short strategy.

Thanks, Kristen. For the quarter and year to date period, financial long short fund returned 2.26%, slightly behind the Russell 3000 financials index. Performance in our short portfolio was particularly good in the quarter with seven of our 10 short positions underperforming the Russell 3000 financials index. In the short portfolio as a whole, underperforming by approximately 400 basis points. This strong performance in the short portfolio helped to partially offset under-performance in the long portfolio, which was driven by NationStar, one of our largest holdings and the name has already been discussed. Turning to industry allocations, valuations of many financials moved upwards over the course of the past year and we used the opportunity to reduce our long exposure across a number of industries, including banks, insurance, capital markets, the one industry where we saw significant additions to our long portfolio within the real estate area where we have added a number of new positions. After being the top performing asset class in five of six years between 2010 and 2015, REITs have been a relative laggard in the past year, which has presented some opportunity in select areas such as storage REITs, which we have already discussed. Turning now to new positions, I’ll highlight one name, Atlas Financial, which is a small cap insurer focused on the transportation industry. That company recently reported a reserve charge for a business in run-off, which led to a significant selloff in the company's shares. We believe this issue has been fully addressed and we're attracted to the core business, which has had very strong underwriting results over its history and the company also has excellent growth opportunities in the future. With that, I’ll turn it back to Kristen.

Thank you, Austin. That concludes our prepared remarks. Adrian, we are now ready to begin the question-and-answer segment at today's call.

[Operator Instructions]

While we wait for questions from the phone, we did receive question via the web and this question is for Kyle. Kyle, what happens to the cost sharing subsidies for the exchanges?

Sure. So just to give everyone some background, 7 million out of the 10 million people with the exchanges receive cost sharing subsidies and Trump has hinted that he may defund the exchanges as sort of a newer option, but that would risk a lot of disruption just because pretty much every remaining insurer needs changes, you’re likely to pull out for 2018 and I think there is just too much backlash. Ultimately, I think they end up funding the cost sharing subsidies. But still big picture, this is 5% of the total insurance market.

Adrian, do we have any questions on the phone?

We have no audio questions at this time. [Operator Instructions]

We’ve got another question from the web and this question is for Chris Welch. How are you thinking about the potential impact of tax reform and how are your research analysts factoring tax reform into their intrinsic value calculation?

Yeah. Thanks for the question. Generally speaking, we're not building expectations for lower corporate taxes into our valuation models. There may be some exceptions, but we've discussed the difference internally between political changes that require a vote - that require a vote and political changes that require a signature. So for example, some regulatory form reductions and in regulatory burdens, some of those things can happen by a signature of the president and we've seen a number of those things already start happening. Things like healthcare the Kyle talked about or tax reform, those things require a vote and even if it requires just a single party vote, there's still a lot of different views on things still out of compromise. It's necessary for things of that nature to occur. So it's much more uncertain that things like tax reform, lowering of tax rates will actually take place. What we have done is our analysts are identifying the potential impacts of tax reform as well as other types of political changes, so the portfolio managers can use that information to the extent that they think those changes are more likely. But generally speaking, we have not incorporated tax reform into our expectations or valuation models.

Thanks, Chris. We received another question via the web. This is for Chris Bingaman. What is your short thesis on Lululemon and is it still a good short after a significant decline in Q1?

Well, yeah, again, we covered it on the decline during the quarter after they announced a fairly meaningful shortfall in their forward guidance. So it's no longer than the portfolio, it's been in and out twice successfully. The general short thesis is just the tremendous amount of new competitors in the space, I mean, Lulu basically invented the category a long time ago. It probably goes back a decade or so and they were very innovative, I would say, and developed a pretty darn good brand I think, but we thought the category was getting very, very saturated and again lots of new competitors along the entire sort of value price spectrum encroaching on their markets. So again, we have a fair amount of respect for the company, what they were able to do, the brand that they developed. I think there's definitely value there, but of course the stock's been very volatile and at times when the valuation has gotten very, very full, we've taken advantage of that in short.

Adrian, do we have any questions on the phone?

We have no audio question at this time.

All right. We have another question from the web. This is for Tom. Can you comment on what your strategy is with Avis and what would cause you to change your outlook and consider selling?

It's always a price relative to our independent estimate of intrinsic value. And so if we were to - potentially due to fundamentals revise downward the intrinsic value estimate or if the price were to increase and at this point, that would be a material increase, then we would perhaps start to sell. To sort of reiterate, a few of the things that I discussed, if you go back since we bought it in April of 2013, for the first, I’ll say, a year and a half, so about six quarters, I think there was a view in the market place that the industry, because it had consolidated down to three main players, enterprise, Hertz and Avis that there would be, to some degree, rational competition, including something perhaps similar to the airline business, where there were some outright capacity reductions and I think that to some degree played out and pricing was positive in the low single digits, but positive and the stock price went from slightly below 30 where we initially bought it to as high as the high-60s. And I think along the way, we maybe took $15 million of profits. And then when pricing went negative in part because perhaps the industry wasn't quite so rational in particular, I think a lot of people are pointing to Hertz as being the party that's been most responsible for at times over-inflating [ph] in the industry, but you can't just put everything on one particular company. But as that turned, the price started to come back down and we started by more. I don’t know if you recall, but early in 2016, the price got to the low-20s and I think as a firm, we added more including in the small cap, we added to it to where it was our largest position. Over 2016, perhaps similar to the pattern this year, the year started off pretty rocky and then recovered a little bit in the second and third quarters of 2016 where pricing did increase and the second and third quarters are by far the most important quarters for the company. And taken all of that together, the EBITDA for Avis was relatively flat in the mid-800 millions. And as I said, they bought $390 million of shares, which reduced the share count I think by about 10%. So in my view, the fundamentals in 2016 were relatively flattish, but the intrinsic value probably went up a bit all else equal by the reduction in share count. And so then forward into 2017, clearly what the market is more concerned about and I shared some of that concern as used car prices and to give rough math to it, a 1% increase in rate per day can offset about 2.5% of unit fleet costs. And so if pricing is flat and unit fleet costs are anywhere from two to, let’s say up 3%, that has a negative EBITDA impact in the tens of millions of dollars, perhaps about $50 million. So that would not be a good scenario, but certainly not anywhere near impacting their ability to continue to buy back shares like they've done. And so what could change very meaningful impacts for much lower residual values which directly impact unit fleet costs or the industry not reacting like I'd expect them to react, which is in the face of that to try to hold capacity at least under demand to try to resolve that from time to time over-inflating difficulties in the industry. And so that's sort of the outlook is that if they were able to continue to generate $300 million plus of free cash flow and continue to buy back stock, I think we should be fine. I think back to a couple other scenarios, for instance in 2011 and 2012, some of our biggest holdings were in the financial sector and they were Assurant and Assured Guaranty. And like Avis, they have very large balance sheets, different businesses of course, but large balance sheets, which they try to earn some kind of spread between their assets and their liabilities and both Assurant and Assured Guaranty essentially pursued a strategy of trying to keep the top line as flat as can be and using significant free cash flow to repurchase shares. Both of those companies went on to do very well in terms of their stock price appreciation. Assurant even better than we would have expected in part because they sold one business to Sun Life that wasn't generating a lot of earnings for a pretty significant sum. I think it was almost $1 billion, I think it was at least over 900 million. And so by pursuing such a strategy, you can have a somewhat challenged top line, and yet if your business is such that you're generating a lot of cash flow, there's a lot of levers you can push to still generate attractive share price returns for shareholders. So that’s a long way of saying that we’ll continue to monitor the relationship between the current price and what our estimate of value is, but right now, there's a pretty large gap between the two and we'll see how the year progresses.

Thanks, Tom. Adrian, any questions on the phone?

We have no audio questions at this time.

Okay. We’ll go ahead and wrap up. As a reminder, for those of you who missed parts of the call or would like to listen to it again, we will post a replay on our website in a few days. Once again, thanks for joining us today and for your continued support of Diamond Hill. We look forward to speaking with you next quarter.