Q:  What is the history of the company? A : Heartland Advisors, Inc. was formed by Bill Nasgovitz in 1984. The company is based in Milwaukee, Wisconsin and is 100% employee owned. Assets under management are just over $4 billion. The Heartland Funds include the Select Value, Value Plus and Value Funds. All three Heartland Funds are managed with the same consistent investment process. Q:  What core beliefs guide your investment philosophy? A : Heartland has consistently utilized the same value-based investment philosophy since the firm’s inception in 1983. We are long-term contrarian investors seeking to buy high quality businesses at distressed valuations. All of our investment strategies utilize the “10 Principles of Value Investing” which is an investment process developed by Heartland’s founder, Bill Nasgovitz, after the bear market of 1974. The 10 Principles are designed to help provide downside protection yet still allow for upside participation. Q:  How does your investment philosophy translate into the investment strategy? A : The Heartland Select Value Fund is a multi-cap fund that has the freedom to invest where valuations are most compelling in the market. There are no market cap restrictions other than the Fund generally does not invest in stocks below $500 million. The fund utilizes Heartland’s 10 Principles of Value Investing, which is a bottoms-up process used to review potential investments. The process provides a consistent framework for analyzing every investment we make. Valuation, business quality, and catalyst for recognition are all key elements of the 10 Principles. We want to make sure we buy companies at an attractive valuation and compelling entry point and to this end look at traditional valuation metrics like price-to-earnings, cash flows, and price-to-book. These metrics should be below historical norms for that industry or sector as well as the broader market metrics. The quality of the business, its management and long-term business strategy are extremely important to us. We favor companies that have strong and defensible positions within their industries. We look for management teams that have a history of success and creating shareholder value. And we prefer financially sound companies. We believe companies with low or no debt not only have less downside risk but also have the financial flexibility to take advantage of potential growth opportunities when presented. Finally, catalyst for recognition is a key component to our investment process. Being able to identify a clear catalyst for why an out-of-favor company will come back in favor with investors is critical to avoiding value traps. A value trap occurs when a company or industry is cheap on valuation metrics and stays cheap for an extended period of time. An example of a value trap would be the newspaper industry. Traditional valuation metrics such as PEs and cash flows certainly got extremely compelling within the sector; however, there was no catalyst. Q:  Can you summarize your ten principles of value investing? A : Number one is catalyst for recognition. Number two is low price to earnings. Three is price to cash flow, four is price to book value, and five is company valuation. What is the intrinsic value or private market value of the company. Number six is financial soundness. We do not like to take balance sheet risk. We like companies that have the flexibility to take advantage of opportunities within the marketplace as well as the flexibility to pay shareholder dividends or to opportunistically buy back their stock. Our belief is that companies that are excessively leveraged do not have that flexibility. Point number seven is capable management and insider ownership. We look for situations where insiders are vested with their shareholders and have a meaningful ownership position and continue to add to their positions. Management experience is also very important to us. We favor situations with seasoned management teams that have extensive industry experience and a history of creating value for shareholders. Point number eight is sound business strategy. Again, we like to buy high-quality businesses with significant market share within an industry and have the ability to maintain and grow market share. Number nine is positive earning dynamics. We believe earnings are the key driver to stock values and multiple expansion. We need to have some expectation that earnings will be able to grow over the long term. Finally, ten is technical analysis. We like stocks with long-term basing patterns. We like to use technical analysis to determine whether or not a stock is truly washed out and other investors have capitulated. Our holdings do not have to meet all ten of the 10 Principles. Typically, we need to have at least seven of the criteria met. The 10 Principles also drive our sell criteria. We review these ten principles on our holdings at least quarterly to make sure valuations are still compelling and the catalyst for recognition remains intact. Q:  What analytical steps involve your research process in terms of idea generation? A : The universe for the Select Value Fund is comprised of about 3,700 stocks. The fund generally invests in domestic stocks with market caps above $500 million. We reduce the universe by screening out companies that do not meet out valuation metrics or have excessive debt. We tend to avoid companies that are over-followed and over-loved by Wall Street. We focus tend to focus on the contrarian and out-of-favor sectors and industries of the market. Once the universe has been reduced to a more manageable size of low-debt companies trading at attractive valuations, we will focus more on fundamental research. As a firm our investment team meets with approximately a 1000 companies a year. We want to have a deep understanding of the company’s business strategy, its management team and the company’s long-term prospects. Q:  Can you give two examples to better illustrate your research process? A : We recently added a name in the utility sector called Black Hills Corporation. Black Hills operates regulated electric and gas utilities located in the Great Plains region. Approximately one third of Black Hills’ assets are in non-regulated energy producing assets including natural gas, oil and coal production and wholesale energy marketing. We believe the company’s valuation is very compelling. Black Hills trades slightly above its tangible book value, which is well below the market averages for the utility sector. The company pays an attractive dividend of 4.6% and has a strong history of rewarding shareholders. In fact the company has increased its dividend each year for 41 consecutive years. We believe there are several catalysts that will drive long-term growth and multiple expansion at Black Hills. The company is in the process of completing two large gas-fired generation plants that will be added to its rate base in early 2012. We believe these two projects will drive meaningful earnings growth in 2012. Black Hills’ earnings have been under pressure during 2011 due to losses in its non-regulated coal mining operation. The losses relate to a below-market coal contract that expires at the end of the year. We expect profitability at the coal mine to normalize in the year ahead. Black Hills controls unexplored shale gas acreage. The company is in the process of drilling exploratory wells to determine the potential value. Exploration should be completed by 2012 and the company will make a decision on how to monetize these assets. And finally, we believe in the current low interest rate environment, high-yielding stocks with a history and the ability to grow their dividends will continue to outperform. A second stock example of a company that we added recently is Capital One Financial Corp. Capital One is a diversified financial services holding company with heavy focus in credit cards. Capital One trades at a very attractive valuation, six times earnings, less than 70% of book value and throws off a significant amount of free cash flow. We believe Capital One is a well run franchise with strong management and excellent brand recognition. The company has significant market share in an industry that is dominated by only a handful of competitors. We see several catalysts in Capital One. The company has fallen out of favor with investors due to declines in its credit card portfolio. This is typical during recessions as consumers pull back on their use of credit. We believe that we have reached an inflection point and the use of credit will gradually begin to increase. In fact, Capital One’s card portfolio has shown a couple quarters of stability. Another catalyst we are very excited about is the fact that Capital One is financially sound and has the flexibility to take advantage of opportunities within the financial sector to grow its business and gain market share. The company has recently announced two very attractively priced acquisitions from distressed sellers. One of the acquisitions is ING’s online banking subsidiary, ING Direct. This acquisition will make Capital One the dominant player in the rapidly growing online banking industry and provide them with cheap funding for their credit card business. The deal pricing is around tangible book value which will make the acquisition very accretive to Capital One. The second acquisition is HSBC’s credit card portfolio. Again Capital One is able to buy a high-quality asset from a distressed seller at an attractive price. When paired with the low-cost funding from the ING purchase this purchase will provide significant earning accretion. Q:  Is the selection criteria same with the small or large, mid cap or generally how do you compare if there is a compelling situation in a small or large cap? A : It’s a bottom-up process driven by our 10 Principles of Value Investing. Recently we have gravitated more towards larger-cap companies as relative valuation multiples have improved verses small and mid. At times small companies may offer more attractive long-term growth prospects which needs to be considered when comparing valuation multiples. Q:  How do you execute your portfolio construction? A : The Heartland Select Value Fund typically invests in about 50 holdings. Our typical holding size is about 2%. We don’t like to take excessive risk on any individual name, sector or industry. We strive for consistent and steady outperformance. Q:  What risks do you focus on and how do you manage them? A : Financial soundness and avoiding balance sheet risk has always been one of our 10 Principles but is especially critical in today volatile environment were credit spread can widen dramatically in a short period of time. Financial strength not only helps in providing downside protection but also provides financial flexibility to take advantage of growth opportunity in the market. We favor companies that pay dividends — 68% of our holdings are dividend payers. We believe consistent and growing dividend payments help provide stability to stocks. Historically, dividend paying stocks have been less volatile than non-dividend payers. We believe having a well defined and time tested investment process is also critical to providing downside protection. The unswerving application of the 10 Principles of Value Investing has not only resulted in consistent performance but has also mitigated downside moves in the market.