Westwood Holdings Group, Inc. — Form 10-Q Summary
Reporting period: Three and six months ended June 30, 2015; filed July 29, 2015. Westwood provides investment advisory, trust and custodial services. Revenue is primarily tied to assets under management (AUM) and financial-market conditions.
Financial performance and position
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Total revenue | $37.3 million | $30.9 million | $66.9 million | $56.9 million |
| Net income | $9.8 million | $8.6 million | $15.4 million | $14.2 million |
| Diluted EPS | $1.23 | $1.12 | $1.93 | $1.82 |
| Economic earnings | $14.4 million | $11.7 million | $23.8 million | $20.9 million |
| Operating cash flow | Not separately provided | Not separately provided | $44.9 million | $16.7 million |
- Q2 revenue increased 21%, while six-month revenue increased 18%. Q2 net income rose 14%; six-month net income rose 9%.
- Q2 net margin was approximately 26.2%, compared with 27.8% in the prior-year quarter. Six-month net margin was approximately 23.0%, compared with 24.9%.
- Asset-based advisory fees increased 24% in Q2 and 21% for the six-month period. Trust fees increased 54% in Q2 and 28% year to date. Performance-based fees declined 44% in Q2 and 42% year to date.
- Total expenses increased 29% in Q2 and 26% year to date, led by employee compensation, information technology, general and administrative costs, and acquisition-related expenses.
- AUM was $23.1 billion at June 30, 2015, up 16% from $20.0 billion at June 30, 2014. The increase included approximately $1.6 billion from the Woodway acquisition.
- Cash and cash equivalents were $22.8 million, compared with $18.1 million at December 31, 2014. Cash and investments totaled $69.0 million at June 30, 2015, versus $97.8 million at year-end.
- Total assets were $156.1 million and stockholders’ equity was $124.4 million at June 30, 2015.
- The company had no debt or liabilities for borrowed money. Working capital was $68.2 million, down from $91.6 million at December 31, 2014.
- Cash dividends declared were $0.50 per share in Q2 and $1.00 per share for the first six months, compared with $0.44 and $0.88, respectively, in the prior-year periods.
Material changes from the prior comparable period
- Westwood completed its acquisition of Woodway Financial Advisors on April 1, 2015. Preliminary consideration was $40.3 million, including $25.3 million of closing-date cash consideration, 109,712 shares issued, and $9.3 million of estimated contingent consideration.
- The acquisition added $2.7 million of revenue and $473,000 of net income during the second quarter and increased goodwill by $11.7 million and net intangible assets by approximately $25.5 million.
- Woodway-related costs contributed to higher compensation, information technology, general and administrative, professional-services and amortization expenses. Six-month professional-services expense included $732,000 of transaction costs.
- Stock-based compensation expense increased to $4.0 million in Q2 and $7.7 million for the six months, from $3.0 million and $6.5 million, respectively.
- The effective tax rate declined to 33.6% in Q2 and 33.4% for the six-month period, from 35.7% and 35.6%, primarily because of increased income generated in Canada.
- The company launched three new mutual funds in Q2, contributing to higher mutual-fund expenses and shareholder-servicing costs.
- AUM increased despite net outflows in Q2 of $216 million; the six-month period had net inflows of $846 million before the Woodway-related AUM contribution.
Cash flow, liquidity and commitments
- Operating activities generated $44.9 million during the first six months. Investing activities used $24.7 million, primarily for the Woodway acquisition, and financing activities used $14.3 million, primarily for dividends and equity-related transactions.
- Management believes existing cash, short-term investments and operating cash flow will fund ordinary operating and capital requirements for at least the next twelve months, including payment of the Woodway earn-out.
- The Woodway earn-out is based on annualized revenue for the period ending March 31, 2016, is capped at $15 million, and had a preliminary fair value of $9.3 million at June 30, 2015. Its valuation is sensitive to revenue growth, client attrition, discount rates and payment probabilities.
- Purchase obligations related to a new information-technology platform totaled $9.5 million, including $1.2 million due within one year. These obligations exclude the Woodway contingent consideration.
Outlook, risks and unusual items
- The filing does not provide formal revenue, earnings or AUM guidance. Management expects ordinary liquidity needs and the Woodway earn-out to be covered by current resources and operating cash flow, but states that additional financing could become necessary.
- Results remain sensitive to market values and the composition of AUM, client inflows and outflows, fee rates, performance-based fees, competition, personnel retention and successful integration of acquired businesses.
- Other identified risks include regulatory changes, cybersecurity and information-system controls, conflicts of interest, insurance coverage, customer concentration, litigation and the ability to develop and market new investment strategies.
- AGF Management and AGF Investments have two pending Canadian lawsuits involving former employees and alleged inducement and defamation claims. Damages sought include unspecified amounts and stated punitive claims; the company cannot estimate the ultimate financial impact. Westwood believes the matters are not currently likely to be material but acknowledges that an adverse resolution could materially affect results.
- Westwood has insurance coverage for 50% of defense costs related to the AGF claims, excluding its counterclaim, and had recorded a $390,000 insurance receivable at June 30, 2015.
- Financial statements are unaudited, and the Woodway purchase-price allocation remains preliminary and could change materially during the measurement period.
- Management concluded that disclosure controls were effective. The assessment of internal control over financial reporting excluded Woodway because it was recently acquired.
Investor verification points
- Verify retention and revenue contribution from Woodway, including the final purchase-price allocation and eventual earn-out obligation.
- Monitor AUM flows, market performance, fee-rate changes and the concentration of revenue among major clients and strategies.
- Assess whether elevated compensation, technology, fund-launch and acquisition-related expenses moderate future margin expansion.
- Review liquidity after dividends, the $9.5 million technology commitment and any cash or stock settlement of the Woodway earn-out.
- Follow the AGF litigation, insurance recoveries and potential exposure despite management’s current assessment of limited expected impact.
- Consider the effect of substantial non-cash stock compensation and intangible amortization when comparing GAAP net income with the company’s Economic Earnings measure.