Westwood Holdings Group, Inc. — Q1 2014 Form 10-Q Summary
Business context and reporting period
Westwood manages investment assets and provides investment advisory, trust and custodial services through its Advisory and Trust segments. Revenue is primarily based on assets under management (AUM), making results sensitive to market performance, client inflows and outflows, fee levels and asset mix. The filing covers the unaudited three months ended March 31, 2014, compared with the three months ended March 31, 2013.
Key financial metrics
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Total revenue | $25.9 million | $20.1 million | 29% |
| Income before taxes | $8.9 million | $4.7 million | 89% |
| Net income | $5.8 million | $2.8 million | 103% |
| Diluted EPS | $0.75 | $0.38 | 97% |
| Operating cash flow | $14.6 million | $5.3 million | 176% |
| Ending cash and cash equivalents | $17.4 million | $5.8 million | Increase of $11.6 million |
| Cash and investments | $62.8 million | Not clearly provided | Compared with $75.4 million at Dec. 31, 2013 |
| Long-term debt | None | Not clearly provided | No borrowed-money liabilities at March 31, 2014 |
| AUM | $19.1 billion | $15.3 billion | 24% |
Revenue consisted of $20.4 million of asset-based advisory fees, $0.4 million of performance-based advisory fees, $5.0 million of trust fees and $0.2 million of other revenue. The approximate pre-tax margin was 34.4% and the net margin was 22.2%, compared with approximately 23.5% and 14.1%, respectively, in Q1 2013.
Advisory fees increased 31% and trust fees increased 19%. Total expenses rose 11% to $17.0 million, including $12.5 million of employee compensation and benefits. Stock-based compensation was $3.2 million, including $0.4 million under the Canadian employee benefit plan. The effective tax rate declined to 35.5% from 40.0%, primarily because Westwood International generated operating income in 2014 versus operating losses in the prior-year period.
Liquidity, capital allocation and balance sheet
- Working capital was $73.6 million at March 31, 2014, compared with $71.3 million at December 31, 2013.
- Operating cash flow was $14.6 million. Investing cash flow used $0.1 million for property and equipment.
- Financing cash flow used $7.9 million, primarily for $3.9 million of dividends and $5.8 million of treasury-stock purchases, partially offset by $1.9 million of excess tax benefits from equity compensation.
- Investments declined to $45.4 million from $64.6 million at December 31, 2013, while cash increased to $17.4 million from $10.9 million.
- The company had no liabilities for borrowed money and stated that cash, short-term investments and operating cash flow should fund ordinary operating and capital needs for at least the next twelve months.
- Common stock dividends declared were $0.44 per share, or $3.6 million, during the quarter.
Material changes versus the prior comparable period
- AUM increased 24% to $19.1 billion, driven by higher beginning AUM, net inflows and market appreciation. Q1 2014 net flows were negative $289 million, partially offset by $438 million of market appreciation.
- Institutional AUM increased 22% to $12.1 billion, private wealth AUM increased 13% to $4.0 billion and mutual fund AUM increased 57% to $3.0 billion.
- Net income more than doubled, despite an 11% increase in total expenses. Economic Earnings, a non-GAAP measure, increased 60% to $9.1 million from $5.7 million.
- Professional services expense increased 38%, Westwood mutual fund expense increased 61%, and general and administrative expense increased 22%.
- Full-time employees increased to 111 from 96 at March 31, 2013.
- Treasury stock increased by approximately $5.8 million, reflecting purchases of 11,476 shares under the Canadian Share Plan and 87,791 shares in employee transactions related primarily to tax withholding.
Guidance, outlook, commentary, risks and unusual items
The filing does not provide formal revenue or earnings guidance. Management stated that future liquidity requirements may depend on operating results, capital expenditures, strategic initiatives and dividend policy, and that ordinary operating and capital needs are expected to be funded through at least the next twelve months.
- Performance-based restricted shares were considered probable of vesting based on a 2014 adjusted pre-tax income goal of at least $34.0 million. Failure to meet performance goals could result in forfeiture and reversal of previously recognized expense.
- Approximately $29.3 million of unrecognized restricted-stock compensation remained at March 31, 2014, expected to be recognized over a weighted-average period of 2.9 years.
- AGF Management Limited and AGF Investments Inc. are pursuing Canadian litigation involving former employees and Westwood. AGF seeks unspecified damages and punitive damages, including claims of $10 million CAD in one action and additional amounts in a second action. Westwood has filed counterclaims. The company cannot estimate the ultimate financial impact and states that an adverse resolution could materially affect results, although it does not currently expect a material impact. Discovery was expected to be completed in Q3 2014.
- Westwood expects 50% of defense costs related to the AGF claims, excluding its counterclaim, to be covered by insurance. It had received approximately $240,000 of insurance proceeds and recorded a $15,000 receivable at March 31, 2014.
- FATCA implementation beginning July 1, 2014 could increase compliance costs, deter some foreign investors and adversely affect the company’s ability to raise funds from foreign investors.
- Principal business risks include financial-market downturns, revenue concentration in four customers, client outflows, fee pressure, competition, retention of investment personnel, regulatory and tax changes, and internal-control risks.
- The company sponsors or advises investment entities with approximately $7.0 billion of aggregate AUM disclosed in the variable-interest-entity table. It concluded that it was not the primary beneficiary of those entities and had no obligation to provide additional financial support beyond contractual commitments.
Important facts for investors to verify
- Whether the substantial year-over-year revenue and earnings growth is sustainable once market appreciation, performance fees and client flows are considered.
- Trends in net client flows, particularly institutional outflows and concentration among four customers.
- The effect of continued stock-based compensation, including the $29.3 million remaining unrecognized expense, on future reported earnings and dilution.
- The status and potential monetary exposure of the AGF litigation and the extent of insurance recovery.
- Future dividend and share-repurchase activity relative to operating cash generation and investment balances.
- FATCA compliance costs and any effect on foreign fundraising or mutual fund AUM.
- The filing’s statement that disclosure controls were effective and that no material changes occurred in internal control over financial reporting during the quarter.