Westwood Holdings Group, Inc. — Q3 2012 Form 10-Q Summary
Business context and reporting period
Westwood manages investment assets and provides investment advisory, trust and custodial services through Westwood Management, Westwood Trust and Westwood International Advisors. Revenue is primarily based on assets under management (AUM), making results sensitive to market performance, asset flows, client concentration and fee pressures. This unaudited quarterly report covers the three and nine months ended September 30, 2012, with comparisons to the same periods in 2011.
Financial performance and position
| Metric | Three months ended September 30 | Nine months ended September 30 |
|---|---|---|
| Total revenue | $18.9 million, up 18% | $56.9 million, up 10% |
| Net income | $2.5 million, down 24% | $8.5 million, down 20% |
| Diluted EPS | $0.34, versus $0.46 | $1.16, versus $1.47 |
| Pre-tax income | $4.3 million, versus $5.3 million | $14.2 million, versus $16.8 million |
| Net margin | 13.2%, versus 20.5% | 14.9%, versus 20.4% |
| Dividends declared per share | $0.37, versus $0.35 | $1.11, versus $1.05 |
- Asset-based advisory fees were $14.5 million in the quarter and $42.7 million for nine months; trust fees were $3.7 million and $10.9 million, respectively.
- Performance-based fees were $69,000 in the quarter and $1.3 million year to date.
- Employee compensation and benefits increased 37% in the quarter and 19% year to date. Total expenses increased 36% and 22%, respectively, outpacing revenue growth.
- Effective tax rates increased to 42.2% for the quarter and 40.0% year to date, primarily due to losses at the lower-taxed Canadian subsidiary, Westwood International.
- AUM was $14.1 billion at September 30, 2012, up 21% from $11.7 billion at September 30, 2011. Third-quarter AUM growth reflected $729 million of market appreciation and $190 million of net inflows; nine-month growth reflected $1.5 billion of market appreciation and $459 million of net outflows.
- Cash and cash equivalents were $6.8 million and investments were $52.9 million at September 30, 2012. Working capital was $58.1 million.
- Operating cash flow was $9.1 million for the nine months, compared with $14.3 million in 2011. Investing activities provided $0.7 million, while financing activities used $8.4 million, principally for dividends and treasury-stock purchases.
- The company had no long-term debt or other borrowed-money liabilities. Management stated that existing cash, short-term investments and operating cash flow should meet ordinary operating and capital requirements for at least the next twelve months.
Material changes versus the prior comparable period
- Revenue growth was driven by higher AUM, market appreciation, client inflows, increased trust fees, performance fees and investment gains.
- Profitability declined because expenses grew faster than revenue. Quarterly employee compensation increased by $3.1 million, including higher multi-year bonus amortization, salaries, performance-based restricted-stock expense and incentive compensation.
- Westwood International began providing investment management services in the third quarter. It had $486 million of external-client AUM and $740 million including subadvised trust assets, but contributed minimal revenue and significant start-up costs during the nine-month period.
- Professional services expense increased 51% year to date, largely due to recruiting and legal costs associated with Westwood International and other professional fees.
- Economic Earnings, a company-defined non-GAAP measure, declined 5% in the quarter to $5.6 million and 11% year to date to $16.6 million. Investors should not treat this measure as a substitute for GAAP net income.
- The company repurchased $3.8 million of common stock during the nine months and authorized a new $10.0 million repurchase program in July 2012. The quarterly dividend was increased to $0.37 per share.
- Investments declined modestly to $52.9 million from $54.9 million at December 31, 2011, while cash increased to $6.8 million from $5.3 million. Accumulated other comprehensive income declined primarily because of investment-market movements.
Outlook, risks, contingencies and unusual items
- The filing does not provide formal revenue, earnings or AUM guidance. Management stated that operating results are not necessarily indicative of future periods.
- Key risks include financial-market downturns, client and revenue concentration, asset outflows, investment-performance shortfalls, competition, fee pressure, retention of qualified personnel, regulatory or legislative changes, effective-tax-rate changes and the ability to develop new investment strategies.
- AGF Management Limited and AGF Investments Inc. filed an Ontario lawsuit alleging contractual and fiduciary breaches by former employees and inducement by Westwood and its recruiting firm. AGF seeks unspecified damages and $10 million of punitive damages. Westwood intends to defend the matter vigorously; the filing does not quantify a probable loss.
- The company completed its annual goodwill impairment assessment during the third quarter and recorded no impairment.
- Investments included $975,000 of Teton shares classified as available-for-sale securities and valued using Level 3 inputs, including a discount for lack of marketability. The company had sold 100,000 Teton shares in the second quarter and retained an option to purchase the remaining 100,000 shares by December 31, 2012.
- Stock-based compensation expense was $7.6 million for the first nine months, and approximately $24.5 million of unrecognized restricted-stock compensation remained at September 30, 2012.
Important facts for investors to verify
- Whether AUM growth is sustained through net client inflows rather than market appreciation alone, particularly given nine-month net outflows.
- The scalability and profitability of Westwood International after its start-up period and the impact of its compensation and recruiting commitments.
- Whether compensation, professional-services and other operating expenses moderate relative to revenue.
- The sensitivity of revenue and earnings to market levels, client concentration, investment performance and fee reductions.
- The potential financial and operational impact of the AGF litigation and any related employee or client-retention issues.
- The sustainability of dividends and share repurchases relative to operating cash flow and investment requirements.
- The valuation and liquidity of Level 3 Teton shares and the effect of future realized or unrealized investment gains and losses.