Westwood Holdings Group, Inc. — Q2 2016 Form 10-Q Summary
Business Context and Reporting Period
Westwood provides investment management, advisory, trust and custodial services to institutional, private wealth and financial intermediary clients through its Advisory and Trust segments. Revenue is primarily based on assets under management (AUM), making results sensitive to market performance, client flows, fee pressure and asset mix. This unaudited Form 10-Q covers the three and six months ended June 30, 2016, compared with the corresponding 2015 periods.
Financial Performance and Position
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Total revenue | $31.0 million | $37.3 million | $60.2 million | $66.9 million |
| Operating expenses | $22.5 million | $22.6 million | $46.0 million | $43.8 million |
| Income before taxes | $8.5 million | $14.8 million | $14.2 million | $23.1 million |
| Net income | $5.7 million | $9.8 million | $9.2 million | $15.4 million |
| Diluted EPS | $0.69 | $1.23 | $1.13 | $1.93 |
| Economic earnings | $10.4 million | $14.4 million | $18.5 million | $23.8 million |
- Net margin was approximately 18.2% in Q2 2016 versus 26.2% in Q2 2015; for the six-month periods, approximately 15.3% versus 23.0%.
- Asset-based advisory fees declined 17% in Q2 and 13% for the first six months. Performance-based fees declined to $0.4 million in Q2 from $1.9 million and to $0.4 million for the six months from $2.2 million.
- Trust fees declined 4% in Q2 but increased 16% for the six months, reflecting the contribution from the Woodway acquisition.
- Information technology expense increased 55% in Q2 and 69% for the six months due primarily to new technology platforms, research and support costs, and Woodway-related expenses.
- Employee compensation and benefits declined 9% in Q2 and 1% for the six months, primarily because of lower incentive compensation accruals.
- Effective tax rates were 33.5% in Q2 2016 versus 33.6% in Q2 2015, and 35.1% for the six months versus 33.4%. The six-month increase included a $322,000 charge related to uncertain tax positions.
- AUM was $21.0 billion at June 30, 2016, down 9% from $23.1 billion at June 30, 2015. Second-quarter net outflows were $860 million, partially offset by $697 million of market appreciation.
- Cash and cash equivalents were $29.1 million at June 30, 2016, compared with $22.7 million at December 31, 2015. Cash and investments totaled $73.9 million, down from $95.1 million at year-end.
- Operating cash flow was $30.6 million for the first six months, compared with $44.9 million in 2015. Investing cash flow used $1.0 million, and financing activities used $24.4 million.
- The company had no debt. Working capital was $76.1 million at June 30, 2016. Management stated that existing cash, short-term investments and operating cash flow should fund ordinary operating and capital requirements for at least the next twelve months.
- Dividends paid during the first six months totaled $10.3 million. A quarterly dividend of $0.57 per share was declared in July 2016, and an additional $5.0 million of share-repurchase authorization was approved.
Material Changes Versus the Prior Comparable Period
- Q2 revenue decreased $6.3 million, or 17%, and six-month revenue decreased $6.8 million, or 10%.
- Q2 net income declined 42%, while six-month net income declined 40%; diluted EPS declined 44% in Q2 and 41% for the six months.
- Economic earnings decreased 28% in Q2 and 22% for the six months.
- AUM declined because of significant net outflows, particularly in SMidCap, SMidCap Plus, LargeCap Value, AllCap Value and Income Opportunity strategies. Market appreciation partially offset those outflows.
- The prior-year comparison benefited from the April 2015 Woodway acquisition, which contributed approximately $1.6 billion of AUM in 2015. Woodway contributed $4.6 million of revenue and $1.0 million of net income during the first six months of 2016.
- The company paid the final $9.3 million Woodway earn-out during the first half of 2016, consisting of $5.6 million in cash and the balance in Westwood shares. The contingent consideration liability was eliminated.
- The company repurchased 93,253 shares for $4.4 million during the first six months at an average price of $47.41 per share.
Outlook, Commentary, Risks and Unusual Items
- No specific revenue, earnings or AUM guidance was provided.
- Management stated that future results depend substantially on AUM composition and market values, client flows, competition and fee levels.
- Key disclosed risks include financial-market volatility, regulatory changes, competition, foreign investments, strategy development, acquisition integration, personnel retention, cybersecurity and information systems, conflicts of interest, insurance coverage, customer concentration and litigation.
- Westwood is defending litigation brought by AGF in Canada concerning former employees and alleged breaches and inducement. The claims include unspecified damages and punitive damages; the company cannot estimate the ultimate financial impact. Management does not currently expect a material impact, but an adverse outcome could materially affect results and cash flows. Fifty percent of certain defense costs is covered by insurance.
- The company recorded a $286,000 first-quarter charge and $13,000 second-quarter income adjustment related to changes in the Woodway earn-out estimate before final settlement.
- Uncertain tax positions totaled $2.1 million at June 30, 2016. The company stated that the liability could decrease by as much as $1.9 million within twelve months, potentially reducing income tax expense by $1.3 million.
- Restricted capital requirements apply to Westwood Trust. At June 30, 2016, Westwood Trust had approximately $12.5 million above its $4.0 million minimum requirement.
- Management reported effective disclosure controls and no material changes to internal control over financial reporting during the quarter.
Most Important Facts for Investors to Verify
- Whether net outflows persist and whether AUM recovers from the $21.0 billion June 30 level.
- The sustainability of asset-based and performance-based fee revenue amid lower AUM and competitive fee pressure.
- Whether elevated technology, headquarters, integration and other operating costs moderate or continue to pressure margins.
- The cash impact of dividends, share repurchases and any further strategic acquisitions, including the effect on liquidity.
- The potential resolution and financial exposure from the AGF litigation and uncertain tax positions.
- The composition and liquidity of the $44.8 million investment portfolio, including restricted capital and corporate seed investments.
- The effect of future accounting standards for financial instruments, leases, revenue recognition and share-based compensation, which were under evaluation as of the filing.