WisdomTree Investments, Inc. — Q3 2013 Form 10-Q
Reporting period: Three and nine months ended September 30, 2013. Financial amounts below are in millions of dollars unless noted. The company sponsors and manages ETFs; advisory fees are primarily based on ETF assets under management (AUM).
Business context
At quarter-end, WisdomTree was the fifth-largest U.S. ETF sponsor, with 53 ETFs and $31.4 billion in AUM. Its product range included equity, fixed-income, currency and alternative-strategy ETFs. The company reported $12.0 billion of net inflows in the first nine months of 2013; $8.8 billion, or 73%, came from its Japan-hedged equity ETF.
Key financial metrics
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Total revenue | $39.6 | $21.7 | $106.3 | $61.2 |
| ETF advisory fees | $39.4 | $21.4 | $105.7 | $60.6 |
| Total expenses | $24.7 | $17.1 | $71.2 | $55.4 |
| Net income | $15.0 | $4.5 | $35.1 | $5.8 |
| Diluted EPS | $0.11 | $0.03 | $0.25 | $0.04 |
| Gross margin (company-defined, non-GAAP) | 76.9% | 68.3% | 74.6% | 66.0% |
- Q3 revenue rose 83.0% year over year and expenses rose 44.0%; management reported a 38% Q3 pre-tax operating margin, compared with 21% a year earlier.
- Average AUM increased 93.2% in Q3 and 78.9% for the nine-month period year over year. The blended advisory fee declined to 0.51% in Q3 from 0.54%, largely due to AUM mix, including growth in the lower-fee Japan-hedged fund.
- Operating cash flow was $47.7 million for the first nine months, versus $7.5 million a year earlier. Investing cash flow was negative $1.8 million and financing cash flow negative $0.1 million. Cash increased $45.9 million to $87.1 million.
- At September 30, cash and cash equivalents were $87.1 million, investments $11.6 million, and current assets $105.3 million; total liabilities were $27.1 million and stockholders’ equity $91.2 million. No debt balance is separately reported in the provided balance sheet.
- Investments were held-to-maturity federal agency debt securities. Their reported fair value was $10.6 million versus $11.6 million amortized cost, including $1.1 million of gross unrealized losses. Management stated it did not intend to sell them before recovery of amortized cost.
Material changes and unusual items
- Q3 growth primarily reflected higher average AUM from strong inflows and market appreciation. Net inflows slowed to $1.2 billion in Q3 from $5.9 billion in Q1 and $5.0 billion in Q2; fixed-income ETFs had $320 million of Q3 outflows amid rising interest rates.
- Operating expenses grew with the business. Compensation and benefits increased 68% in Q3, fund management and administration costs 55%, and marketing and advertising 136%. Headcount rose to 84 from 70 a year earlier.
- The BNY Mellon collaborative arrangement ended in 2012, shifting certain fund operating costs to WisdomTree and reducing third-party sharing expense. Prior-year comparisons also included $3.3 million of ETF shareholder proxy expense and $0.7 million of net patent-litigation expense in the first nine months; neither recurred in 2013.
- The company dissolved its retirement-services subsidiary in September 2013. It repurchased shares solely to cover employee tax withholding on vested restricted stock; these were not purchases under a public buyback plan.
Outlook, risks and contingencies
- No specific revenue or earnings guidance is provided. Management said operating cash flows should fund operations for at least the next 12 months.
- WisdomTree agreed to transfer fund administration and custody services from BNY Mellon to State Street effective April 1, 2014. Management estimated that State Street pricing, if applied in Q3, would have reduced fund expenses by about $1.5 million for the quarter, or $6 million annualized, and improved gross margin by four percentage points. These are estimates, not realized savings.
- A new 16-year office lease was signed in August 2013. Future minimum operating-lease payments totaled $44.9 million, including $29.6 million due after five years. Management expected an additional $0.7 million of rent expense in Q4 2013 and higher future depreciation from office improvements.
- Results are sensitive to ETF inflows, market levels, foreign-exchange movements, interest rates, investor sentiment, and competition. The Japan-hedged ETF was a particularly large source of 2013 inflows. Management cited new competing fundamental and currency-hedged ETFs.
- The company said it was not party to legal proceedings expected to have a material impact. A patent infringement suit filed in 2011 was withdrawn and settled in 2012; insurance funded most defense costs. Routine regulatory reviews and inspections may occur.
- The company reported no income-tax provision for the periods presented and said a full valuation allowance was recorded against deferred tax assets related to net operating losses.
Important facts for investors to verify
- Whether the exceptional Japan-hedged ETF inflows persist, and how net flows and AUM develop across product categories.
- Whether the State Street transition delivers the estimated expense savings and gross-margin improvement from April 2014.
- How the long-term office lease and related build-out affect recurring costs, cash needs and depreciation.
- The investment portfolio’s fair-value deficit, liquidity terms and any changes to management’s ability or intention to hold securities to maturity.
- Potential effects of market, currency, interest-rate and competitive changes on AUM, fee mix and revenue; the filing provides no formal forward earnings guidance.