Business Context and Reporting Period
Westwood Holdings Group, Inc. filed this Form 10-K for the fiscal year ended December 31, 2013. The company provides investment advisory, trust, custodial and related services through Westwood Management, Westwood Trust and Westwood International Advisors. Revenue is primarily based on fees calculated as a percentage of assets under management (AUM).
Westwood managed approximately $18.9 billion of AUM at year-end 2013, including advisory, private wealth, mutual fund and international strategies. The company had 106 full-time employees and operates in the United States and Canada.
Financial Results and Key Metrics
| Metric | 2013 | 2012 | Change |
|---|---|---|---|
| Total revenue | $91.825 million | $77.495 million | +18% |
| Total expenses | $63.556 million | $57.469 million | +11% |
| Income before taxes | $28.269 million | $20.026 million | +41% |
| Net income | $17.891 million | $12.090 million | +48% |
| Diluted EPS | $2.34 | $1.65 | +42% |
| Operating cash flow | $21.707 million | $13.780 million | +57% |
| Cash and investments | $75.418 million | $63.723 million | +18% |
| Stockholders’ equity | $88.633 million | $76.551 million | +16% |
| AUM at year-end | $18.931 billion | $14.167 billion | +34% |
Asset-based advisory fees were $70.027 million, up 21%; performance-based fees were $2.561 million, up from $1.251 million; and trust fees were $18.367 million, up 23%. Other revenues declined to $0.870 million from $3.339 million, primarily because 2012 included a $1.9 million gain on the sale of Teton Advisors shares.
The pretax margin was approximately 30.8%, compared with 25.8% in 2012. The net margin was approximately 19.5%, compared with 15.6% in 2012. The effective tax rate declined to 36.7% from 39.6%, primarily because Westwood International’s operating losses declined and were subject to a lower Canadian tax rate.
Economic Earnings, a non-GAAP measure, increased 29% to $29.997 million from $23.231 million. This measure adds restricted stock expense, intangible amortization and deferred taxes related to goodwill amortization to GAAP net income.
Liquidity, Capital Resources and Debt
- Cash and cash equivalents were $10.864 million, and investments were $64.554 million, at December 31, 2013.
- Working capital was $71.3 million, compared with $58.5 million at year-end 2012.
- The company reported no long-term debt and no liabilities for borrowed money at December 31, 2013.
- Operating cash flow of $21.707 million funded ordinary operations. Investing cash flow was $(1.201) million, primarily for property and equipment. Financing cash flow was $(13.303) million, primarily reflecting dividends and treasury stock purchases.
- Westwood Trust held approximately $12 million in capital above its $1.0 million regulatory minimum. Westwood International exceeded its Canadian working-capital requirement by approximately C$4.4 million.
- Management believes existing cash, short-term investments and operating cash flow will be sufficient for ordinary operating and capital requirements through at least the next twelve months.
- Non-cancelable operating lease commitments totaled $9.169 million, including $1.422 million due in 2014.
Material Changes Versus the Prior Comparable Period
- AUM increased 34% to $18.9 billion, driven by $4.3 billion of inflows and $3.3 billion of market appreciation, partially offset by $2.8 billion of outflows.
- Mutual fund AUM increased 74% to $2.8 billion. Westwood International AUM increased to $2.5 billion from $888 million, including more than $500 million of inflows into the newly launched Ireland-domiciled UCITS fund.
- The Income Opportunity strategy exceeded $2.8 billion of AUM and generated more than $700 million of net inflows.
- Outflows were primarily associated with withdrawals and rebalancing in the LargeCap Value strategy. Management disclosed recent underperformance in LargeCap Value, SMidCap Value and Emerging Markets strategies.
- Employee compensation and benefits increased 9% to $47.780 million, while mutual fund expenses increased 87% to $2.153 million as fund assets and servicing costs grew.
- Westwood International generated $9.6 million of revenue and incurred $12.2 million of costs in 2013, compared with $1.8 million of revenue and $10.3 million of costs in 2012.
- The quarterly dividend increased to $0.44 per share in the fourth quarter, from $0.40 in the prior three quarters. Total dividends declared were $1.64 per share in 2013 versus $1.51 in 2012.
Outlook, Management Commentary, Risks and Unusual Items
Management’s growth priorities include expanding existing strategies, growing Westwood Trust and mutual fund distribution, expanding international distribution, developing or acquiring investment strategies, strengthening consultant relationships and attracting and retaining investment professionals. The filing does not provide formal quantitative revenue or earnings guidance.
- Results remain highly dependent on investment performance, market appreciation, client flows and the retention of advisory, subadvisory and trust mandates.
- The four largest clients represented approximately 13.7% of 2013 fee revenue. Advisory and trust agreements generally may be terminated on short notice, and mutual fund investors may redeem without prior notice.
- LargeCap Value and SMidCap Value strategies represented approximately 49% of consolidated revenue and had underperformed their benchmarks and ranked below peer medians over the trailing three-year period ended December 31, 2013. The Emerging Markets strategy had also underperformed since inception.
- Competition, fee pressure, increased use of passive products, market volatility, concentration in equity and large-capitalization strategies, and international and foreign-exchange risks could reduce AUM and margins.
- The company is defending two Ontario lawsuits brought by AGF relating to the hiring of members of Westwood International’s investment team. AGF seeks unspecified damages and punitive damages, including stated claims of C$10 million in one action and C$5 million in general damages plus other amounts in another. Westwood’s counterclaims also seek damages. The ultimate financial impact cannot currently be estimated; 50% of defense costs for the AGF claims, excluding Westwood’s counterclaim, is expected to be covered by insurance.
- Westwood International has Canadian net operating-loss carryforwards of approximately $8.5 million supporting a $2.2 million deferred tax asset. No valuation allowance was recorded, but an adverse change in forecasts could reduce future net income.
- No goodwill impairment was recorded in 2013. The company reported effective disclosure controls and effective internal control over financial reporting, and the independent auditor issued an unqualified opinion.
Important Facts for Investors to Verify
- Whether recent and future investment performance, especially in LargeCap Value, SMidCap Value and Emerging Markets, leads to sustained client outflows.
- The composition and persistence of the $18.9 billion AUM increase, including the relative contribution of market appreciation, new inflows and potentially less stable mutual fund or international assets.
- The financial performance and path to profitability of Westwood International, including utilization of its deferred tax assets.
- The status, insurance coverage and potential exposure from the AGF litigation and related counterclaims.
- The sustainability of the $0.44 quarterly dividend, given holding-company dependence on subsidiary dividends and Westwood Trust’s regulatory distribution limitations.
- The effect of stock-based compensation, which totaled $11.595 million in 2013 and had approximately $21.9 million of unrecognized restricted-stock compensation cost at year-end.
- Whether fee compression, market declines, client concentration or strategy capacity constraints could reduce revenue and operating margins.