Westwood Holdings Group, Inc. — Q2 2014 Form 10-Q Summary
Business Context and Reporting Period
Westwood manages investment assets and provides investment advisory, trust, custodial and related services through Westwood Management, Westwood Trust, Westwood International and Westwood Advisors. Revenue is primarily based on assets under management (AUM), making results sensitive to market performance, client flows, fee rates and asset mix. This unaudited Form 10-Q covers the three and six months ended June 30, 2014, compared with the corresponding 2013 periods.
Key Financial Metrics
| Metric | Three Months Ended June 30, 2014 | Three Months Ended June 30, 2013 | Six Months Ended June 30, 2014 | Six Months Ended June 30, 2013 |
|---|---|---|---|---|
| Total revenue | $30.9 million | $23.5 million | $56.9 million | $43.6 million |
| Income before taxes | $13.7 million | $7.7 million | $22.6 million | $12.5 million |
| Net income | $8.8 million | $4.9 million | $14.6 million | $7.7 million |
| Basic EPS | $1.17 | $0.66 | $1.94 | $1.05 |
| Diluted EPS | $1.14 | $0.65 | $1.89 | $1.03 |
| Operating cash flow | Not separately provided | Not separately provided | $16.7 million | $9.7 million |
Calculated margins were approximately 44.4% pretax and 28.5% net for the second quarter, compared with approximately 32.9% and 20.8%, respectively, in the prior-year quarter. For the six-month period, pretax and net margins were approximately 39.8% and 25.6%, compared with 28.6% and 17.7% in 2013.
- Asset-based advisory fees were $22.1 million in the quarter and $42.5 million year to date. Performance-based fees were $3.4 million and $3.8 million, respectively.
- Trust fees were $5.2 million in the quarter and $10.2 million year to date.
- Total expenses increased 9% in the quarter and 10% year to date, to $17.2 million and $34.2 million, respectively.
- The effective tax rate was 35.7% for the quarter and 35.6% year to date, down from 36.9% and 38.1% in the comparable 2013 periods.
- AUM was $20.1 billion at June 30, 2014, up 27% from $15.8 billion at June 30, 2013. The increase reflected market appreciation and inflows, partly offset by client outflows.
- Economic Earnings, a non-GAAP measure, increased 45% to $11.6 million for the quarter and 51% to $20.6 million year to date. This measure adds back restricted stock expense, intangible amortization and deferred taxes on goodwill.
Balance Sheet, Cash Flow, Debt and Liquidity
- Cash and cash equivalents were $16.1 million at June 30, 2014, compared with $10.9 million at December 31, 2013.
- Investments at fair value were $57.8 million, down from $64.6 million at year-end. Cash and investments totaled $73.8 million, compared with $75.4 million at December 31, 2013.
- Total assets were $115.2 million and stockholders’ equity was $98.0 million at June 30, 2014.
- Total liabilities declined to $17.2 million from $27.4 million at year-end, primarily reflecting lower compensation and benefits payable and income taxes payable.
- The company reported no debt or liabilities for borrowed money.
- Year-to-date operating cash flow of $16.7 million exceeded $11.2 million of financing cash uses, consisting primarily of $7.3 million of dividends and $5.8 million of treasury stock purchases. Capital expenditures were $302,000.
- Working capital was $80.5 million at June 30, 2014, compared with $71.3 million at December 31, 2013. Management believes cash, short-term investments and operating cash flow are sufficient for ordinary requirements for at least the next twelve months.
Material Changes Versus the Prior Comparable Period
- Second-quarter revenue increased 32%, while net income increased 81%; year-to-date revenue increased 30% and net income increased 89%.
- AUM growth was driven primarily by market appreciation and increased institutional and mutual fund assets. Second-quarter net flows were positive $77 million, but year-to-date net flows were negative $212 million because outflows exceeded inflows.
- Employee compensation and benefits increased 5% in both the quarter and year-to-date period. Headcount rose to 116 full-time employees from 99 a year earlier.
- Information technology expense increased 50% in the quarter and 30% year to date; Westwood mutual fund expense increased 56% and 59%, respectively; and professional services expense increased 10% and 24%.
- Restricted stock compensation remained significant at $5.8 million year to date, with approximately $29.0 million of unrecognized restricted-stock compensation expense remaining at June 30, 2014.
- The company repurchased approximately $5.8 million of treasury stock year to date and declared dividends of $0.44 per share.
Outlook, Risks, Contingencies and Unusual Items
The filing does not provide formal revenue, earnings or AUM guidance. Management expects ordinary operating and capital requirements to be funded by existing cash, investments and operating cash flow, but notes that additional financing could become necessary depending on results, capital needs, strategic initiatives and dividend policy.
- Results depend heavily on financial-market conditions, AUM levels and composition, client retention, investment performance, fee pricing and net flows.
- Revenue is concentrated among four customers, and the company faces competition, fee pressure, personnel-retention risk and risks associated with developing new investment strategies.
- AGF Management Limited and AGF Investments Inc. have pending Ontario litigation concerning the hiring of Westwood’s global and emerging markets team and alleged defamatory statements. Damages sought include unspecified amounts and punitive damages. Westwood cannot estimate the ultimate financial impact; adverse resolution could materially affect results, although management does not currently expect a material impact. Fifty percent of defense costs for the AGF claims, excluding Westwood’s counterclaim, is expected to be covered by insurance.
- The company sponsors or advises various variable-interest entities but concluded it is not the primary beneficiary and therefore does not consolidate them. Reported corporate investment and risk of loss in the Westwood Funds and common trust funds totaled $5.6 million.
- New accounting standards on discontinued operations, revenue recognition and performance-based share payments were issued. The company does not expect the discontinued-operations or share-payment standards to have a significant impact and was still evaluating the revenue standard.
- Management concluded that disclosure controls and procedures were effective, with no material changes to internal control over financial reporting during the quarter.
Important Facts for Investors to Verify
- Whether AUM growth is sustained through net client inflows rather than market appreciation alone, particularly given negative year-to-date net flows.
- The concentration and retention of the company’s largest customers and the effect of any fee reductions or mandate losses.
- The effect of equity-market performance and investment-product performance on AUM, performance fees and earnings.
- The potential cash impact and insurance coverage of the AGF litigation and related counterclaims.
- The magnitude and timing of restricted-stock compensation, incentive compensation and treasury-stock purchases relative to operating cash flow.
- Future dividend policy, repurchase activity and the company’s continued ability to operate without debt financing.