Westwood Holdings Group, Inc. — 2018 Q3 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018; filed October 24, 2018. Westwood provides investment advisory, trust and custodial services. Revenue is substantially driven by assets under management, market performance and client flows.
Financial performance and position
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Total revenue | $29.9 million | $33.5 million | $96.2 million | $99.9 million |
| Net operating income | $7.2 million | $5.8 million | $28.1 million | $24.1 million |
| Income before taxes | $7.2 million | $5.8 million | $28.6 million | $24.1 million |
| Net income | $5.4 million | $4.1 million | $21.3 million | $17.1 million |
| Diluted EPS | $0.62 | $0.49 | $2.49 | $2.05 |
| Economic Earnings | $9.5 million | $9.0 million | $34.4 million | $31.3 million |
- Revenue declined 11% in the quarter and 4% year to date. Operating margin improved to approximately 24.0% from 17.2% in the quarter and to 29.2% from 24.1% year to date. Net margin was approximately 18.0% versus 12.3% in the quarter and 22.2% versus 17.1% year to date.
- Assets under management were $20.8 billion at September 30, 2018, down 12% from $23.6 billion a year earlier. Year-to-date net outflows were $3.9 billion, partly offset by $509 million of market appreciation.
- Cash and cash equivalents were $48.1 million, and cash plus short-term investments totaled $119.1 million. Working capital was $117.1 million. The company had no debt.
- Operating cash flow was $15.1 million for the first nine months, compared with $39.4 million in the prior-year period. Investing cash flow was $3.9 million, including $10.0 million of proceeds from the Omaha divestiture and a $5.4 million strategic private-company investment. Financing cash outflow was $24.3 million, primarily dividends and equity-related payments.
- Total assets were $192.6 million and stockholders’ equity was $164.7 million at September 30, 2018.
- Cash dividends declared were $2.04 per share for the first nine months. In October 2018, the quarterly dividend was increased 6% to $0.72 per share, payable January 2, 2019.
Material changes versus the prior comparable period
- Asset-based advisory fees fell 13% in Q3 and 5% year to date, primarily because of lower average AUM. Trust fees fell 8% in Q3 and 6% year to date.
- Year-to-date performance-based advisory fees increased to $3.0 million from $1.4 million.
- Net income increased 30% in Q3 and 25% year to date despite lower revenue, primarily reflecting the absence of the $4.0 million net legal-settlement charge recorded in Q3 2017, lower employee compensation and lower taxes.
- Information technology expense increased 26% in Q3 and 23% year to date because of technology infrastructure implementation and research investments.
- The Omaha-based Private Wealth operation was sold on January 12, 2018, generating $10.0 million of proceeds and a $524,000 gain. The divestiture reduced AUM, goodwill and intangible assets.
- Goodwill declined to $19.8 million from $27.1 million at year-end 2017, primarily due to the Omaha divestiture. Management’s third-quarter impairment test identified no goodwill impairment.
- The effective tax rate decreased to 24.9% from 28.2% in Q3 and to 25.3% from 29.1% year to date, benefiting from the Tax Cuts and Jobs Act. A $251,000 state tax audit charge and $81,000 of related interest were recorded in Q3.
Outlook, risks and unusual items
- Management stated that existing cash and short-term investments, together with operating cash flow, should be sufficient for ordinary operating and capital needs for at least the next twelve months. No formal revenue or earnings guidance was provided.
- Approximately $30 million of cash and cash equivalents represented undistributed income from Westwood International. Repatriation could generate additional Canadian withholding taxes, although management currently intends to permanently reinvest the funds outside the United States.
- Westwood Trust held approximately $16.8 million above its $4.0 million minimum restricted-capital requirement.
- The company expects adoption of the new lease standard on January 1, 2019 to add approximately $8 million of lease assets and net lease liabilities, with no material expected impact on income or cash flow.
- The company made a $5.4 million investment in a private company using a cost-based measurement alternative. Management reported no impairment indicators or observable price changes at September 30, 2018.
- Key risks include market-driven AUM volatility, continued net outflows, fee pressure and competition, customer concentration, personnel retention, regulatory requirements, cybersecurity and information systems, third-party vendors, conflicts of interest, litigation, insurance coverage and execution of strategic initiatives.
- The prior AGF litigation was settled in 2017; all related insurance proceeds were received during the first nine months of 2018. The filing reported no current legal proceedings.
- Management concluded that disclosure controls were effective and reported no material changes to internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether net outflows continue, particularly in Emerging Markets, SMidCap, Income Opportunity and LargeCap Value strategies.
- The sustainability of revenue and margins as AUM remains below the prior-year level and depends on market appreciation and client retention.
- The performance and valuation of the $5.4 million private-company investment and other seed investments.
- The cash-flow impact of dividends, equity compensation, technology commitments and the planned lease-accounting changes.
- The effect of the Omaha divestiture on future advisory and trust revenue, AUM and operating expenses.
- The company’s continued ability to fund its dividend policy from operating cash flow without debt financing or additional capital.