Westwood Holdings Group, Inc. — Q1 2016 Form 10-Q Summary
Business context and reporting period
Westwood provides investment management, trust and custodial services through its advisory and trust subsidiaries. Revenue is primarily driven by assets under management (AUM), making results sensitive to market values, client flows, fee rates and client concentration. This unaudited quarterly report covers the three months ended March 31, 2016, with comparison to the three months ended March 31, 2015.
- AUM was $21.1 billion at March 31, 2016, down 2% from $21.6 billion at March 31, 2015.
- First-quarter net AUM flows were negative $48 million, consisting of $893 million of inflows and $941 million of outflows; market appreciation added $421 million.
- The Woodway acquisition, completed April 1, 2015, contributed $2.4 million of revenue and $611,000 of net income in the first quarter of 2016.
Financial performance and liquidity
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Total revenue | $29.1 million | $29.6 million | Down 2% |
| Income before taxes | $5.6 million | $8.4 million | Down 33% |
| Net income | $3.5 million | $5.6 million | Down 37% |
| Diluted EPS | $0.44 | $0.71 | Down 38% |
| Economic Earnings | $8.1 million | $9.4 million | Down 14% |
| Economic Earnings per diluted share | $1.01 | $1.20 | Down 16% |
| Operating cash flow | $17.2 million | $13.8 million | Up 25% |
| Cash and cash equivalents | $26.4 million | $19.6 million | Up $6.8 million |
| Cash and investments | $71.2 million | Not clearly provided for the comparable quarter | Not comparable from filing text |
Asset-based advisory fees declined 9% to $21.8 million, while trust fees increased 45% to $7.5 million, principally due to Woodway. Performance-based advisory fees were zero versus $288,000 in the prior-year quarter. Other revenues were negative $151,000, including a $286,000 charge for an increase in the estimated Woodway contingent consideration.
Total expenses increased 11% to $23.5 million. Employee compensation increased 8% to $16.5 million, information technology expense increased 89% to $2.0 million, and general and administrative expense increased 48% to $2.4 million. Professional services expense decreased 21% to $1.6 million, primarily because the prior-year period included Woodway transaction costs.
Pre-tax margin was approximately 19.4% versus 28.3% in the prior-year quarter. Net margin was approximately 12.1% versus 19.0%. The effective tax rate increased to 37.6% from 33.0%, primarily because of a $251,000 charge related to uncertain tax positions.
The company had no debt as of March 31, 2016. Working capital was $66.5 million, compared with $72.7 million at December 31, 2015. Westwood Trust had approximately $6.2 million in excess of its $4.0 million minimum restricted-capital requirement.
- Cash flow from investing activities was negative $378,000, primarily for property and equipment.
- Cash flow from financing activities was negative $14.3 million, including $5.7 million of dividends and $4.4 million of share repurchases.
- The quarterly dividend was increased to $0.57 per share from $0.50 per share in the prior-year quarter. A $0.57 per-share dividend was declared in April 2016 for payment July 1, 2016.
Material changes versus the prior comparable period
- Revenue was broadly stable, but the mix shifted from advisory to trust fees following the Woodway acquisition.
- Lower average advisory AUM reduced asset-based fees, while performance-based fees were absent.
- Expenses rose faster than revenue because of Woodway-related personnel and operating costs, new information technology platforms, higher amortization and increased headcount.
- Net income and GAAP EPS declined substantially, while operating cash flow improved due in part to net sales of trading investments and working-capital movements.
- Economic Earnings declined less than GAAP net income but still fell 14%, reflecting higher stock-based compensation and intangible amortization add-backs.
- The company repurchased 93,053 shares for $4.4 million at an average price of $47.41. Treasury stock also increased through employee-plan activity and shares withheld for taxes.
- Investments declined to $44.8 million from $72.3 million at December 31, 2015, while cash increased to $26.4 million.
Guidance, outlook, management commentary, risks and unusual items
Management did not provide formal revenue or earnings guidance in the filing. Management stated that existing cash, short-term investments and operating cash flow should be sufficient for ordinary operating and capital requirements for at least the next twelve months, including payment of the Woodway contingent consideration, although additional financing could be required.
- The estimated Woodway earn-out liability increased to $9.3 million, with a $286,000 charge recorded in other revenues. The earn-out is payable 54.84% in cash and 45.16% in Westwood shares.
- The company had $2.0 million of gross liabilities for uncertain tax positions. Within the next twelve months, the liability could decrease by as much as $1.9 million; if recognized, the related tax benefit could reduce income tax expense by approximately $1.3 million.
- Westwood is defending litigation brought by AGF relating to former employees and alleged inducement of breaches. Damages are unspecified, with punitive-damage claims stated in Canadian dollars. The company cannot estimate the ultimate financial impact and believes the proceedings are not currently expected to be material, but an adverse resolution could materially affect results.
- Fifty percent of defense costs for the AGF claims, excluding Westwood’s counterclaim, are covered by insurance. The company had received approximately $928,000 of insurance proceeds and recorded a $94,000 receivable at March 31, 2016.
- Key business risks include market and AUM declines, client outflows and concentration, fee pressure, competition, personnel retention, acquisition integration, regulatory changes, litigation, cybersecurity, information systems and internal controls.
- Management concluded that disclosure controls and procedures were effective and reported no material changes in internal control over financial reporting during the quarter.
- The company is evaluating recently issued accounting standards covering financial instruments, leases, revenue recognition and share-based compensation. The filing states that ASU 2016-08 and ASU 2016-10 are not expected to have a material impact.
Important facts for investors to verify
- Whether advisory AUM and net flows stabilize or continue to decline, particularly in institutional and mutual-fund strategies.
- The retention and revenue performance of Woodway clients and the final amount and timing of the earn-out payment.
- Whether higher technology, compensation, amortization and other operating costs normalize or continue to pressure margins.
- The sustainability of the $0.57 quarterly dividend, share repurchases and other capital-return activity relative to operating cash flow.
- The resolution and potential cost of the AGF litigation and the extent of available insurance recoveries.
- The outcome of uncertain tax positions and any resulting tax benefit or expense.
- The effect of market conditions, fee compression, client concentration and regulatory or cybersecurity events on future revenue.