Business Context and Reporting Period
Westwood Holdings Group, Inc. is an investment management company serving institutional investors, private wealth clients and financial intermediaries through advisory and trust businesses. Revenue is primarily based on assets under management (AUM), making results sensitive to market performance, client flows and asset mix.
This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2014, compared with the corresponding 2013 periods. The company had 8,290,018 common shares outstanding as of October 17, 2014.
Key Financial Metrics
| Metric | Three months ended September 30, 2014 | Three months ended September 30, 2013 | Nine months ended September 30, 2014 | Nine months ended September 30, 2013 |
|---|---|---|---|---|
| Total revenue | $28.1 million | $23.0 million | $85.0 million | $66.6 million |
| Income before taxes | $10.6 million | $6.7 million | $32.6 million | $19.3 million |
| Net income | $7.1 million | $4.3 million | $21.3 million | $12.1 million |
| Diluted EPS | $0.92 | $0.57 | $2.73 | $1.57 |
| Operating cash flow | Not provided for the quarter | Not provided for the quarter | $20.9 million | $19.2 million |
| Economic Earnings | $10.9 million | $7.3 million | $31.8 million | $21.0 million |
- Net income margins were approximately 25.3% for the third quarter and 25.0% for the first nine months. Pre-tax margins were approximately 37.7% and 38.3%, respectively.
- Asset-based advisory fees were $22.9 million in the third quarter and $65.3 million for the first nine months. Trust fees were $5.3 million and $15.5 million, respectively.
- AUM was $19.8 billion at September 30, 2014, up 15% from $17.1 billion at September 30, 2013. Mutual fund AUM increased 44%, institutional AUM increased 13% and private wealth AUM increased 6%.
- Cash and cash equivalents were $16.5 million at September 30, 2014, compared with $10.9 million at December 31, 2013. Cash and investments totaled $89.6 million, compared with $75.4 million at year-end 2013.
- Working capital was $84.1 million at September 30, 2014, compared with $71.4 million at December 31, 2013.
- The company reported no debt or liabilities for borrowed money. Total liabilities were $27.7 million and stockholders’ equity was $104.9 million.
- Cash dividends declared were $0.44 per share in the third quarter and $1.32 per share for the first nine months, compared with $0.40 and $1.20, respectively, in 2013.
Material Changes Versus the Prior Comparable Period
- Third-quarter revenue increased 22%, while nine-month revenue increased 28%, primarily due to higher average AUM and stronger asset-based advisory fees.
- Third-quarter net income increased 65%; nine-month net income increased 76%. Diluted EPS increased 61% for the quarter and 74% for the nine-month period.
- Operating expenses increased 8% in the third quarter and 11% for the first nine months, below the corresponding revenue growth rates. Employee compensation and benefits increased 6% and 8%, respectively.
- The effective tax rate declined to 32.8% from 36.2% in the third quarter and to 34.7% from 37.4% for the first nine months, primarily reflecting income generated by the Canadian operation at a lower tax rate.
- Third-quarter AUM declined $332 million sequentially because of $428 million of market depreciation and $1.0 billion of outflows, partly offset by $1.1 billion of inflows. Nine-month AUM increased $839 million, reflecting $955 million of market appreciation and $2.7 billion of inflows, offset by $2.8 billion of outflows.
- Cash provided by operating activities increased to $20.9 million from $19.2 million. Financing cash outflows increased to $14.6 million from $10.3 million, primarily because of higher dividend payments and restricted stock tax withholding.
Outlook, Commentary, Risks and Unusual Items
- 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, although additional financing cannot be ruled out.
- The filing does not provide formal revenue, earnings or AUM guidance. Management noted that results remain dependent on financial markets, client flows, asset composition, fee levels and investment performance.
- Management identified risks including customer and revenue concentration, competition and fee pressure, retention of qualified personnel, development of new investment strategies, market downturns, interest rates, tax-rate changes, regulation and internal controls.
- The company corrected prior-period stock-based compensation measurement errors. The cumulative non-cash correction increased stock-based compensation expense and reduced reported net income by approximately $3.3 million from 2006 through June 30, 2014; the first half of 2014 correction was approximately $0.4 million. Prior-period amounts were revised for comparability, with no net effect on total stockholders’ equity at December 31, 2013.
- Stock-based compensation expense was $10.1 million for the first nine months, compared with $8.5 million in 2013. Approximately $18.8 million of unrecognized restricted-stock compensation remained at September 30, 2014.
- The company completed its annual goodwill impairment assessment and recorded no impairment.
- Westwood is defending two Canadian lawsuits brought by AGF relating to former employees and alleged defamatory statements. AGF seeks unspecified damages and stated punitive damages of up to $10 million Canadian in the first action and additional damages in the second. The company cannot estimate the ultimate financial impact, does not currently believe the proceedings will be material, and has insurance coverage for 50% of defense costs related to the AGF claims, excluding the counterclaim.
- In October 2014, the board declared a quarterly dividend of $0.50 per share, a 14% increase from the prior quarterly rate, payable January 2, 2015.
- Management concluded that disclosure controls and procedures were effective as of September 30, 2014, with no material changes in internal control over financial reporting.
Important Facts for Investors to Verify
- Whether AUM growth can continue given third-quarter net outflows and market depreciation, particularly in the LargeCap Value strategy.
- The sustainability of the strong revenue and earnings growth, including the contribution from performance-based fees and market appreciation.
- The effect of elevated stock-based compensation and the remaining unrecognized compensation expense on future reported earnings and dilution.
- The status, costs, insurance recoveries and potential exposure associated with the AGF litigation.
- The company’s ability to maintain its increased dividend while funding operations, employee compensation, share-related tax obligations and any strategic initiatives.
- The accuracy and comparability of revised prior-period results following the stock-based compensation error correction.