WisdomTree Investments, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Unless otherwise noted, financial amounts below are in U.S. dollars; the filing presents most financial statement amounts in thousands. ETFS results are included only from its April 11, 2018 acquisition date, limiting year-over-year comparability.
Business context and reporting period
WisdomTree sponsors and manages exchange-traded products (ETPs), earning substantially all revenue from advisory fees based on average daily assets under management (AUM). It reports U.S. and International business segments. The April acquisition of ETFS added a large European commodities, currency, and leveraged/inverse ETP business. WisdomTree reported global AUM of $60.0 billion at June 30, 2018, including $17.6 billion acquired with ETFS.
Financial and operating metrics
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $74.8 million | $56.2 million | $133.7 million | $109.6 million |
| Operating income | $14.5 million | $15.0 million | $27.8 million | $28.6 million |
| Net income | $16.7 million | $12.1 million | $26.1 million | $19.0 million |
| Diluted EPS | $0.10 | $0.09 | $0.17 | $0.14 |
| Operating cash flow | Not separately provided for the quarter | Not separately provided for the quarter | $9.0 million | $17.3 million |
- Q2 revenue grew 33.0% year over year, primarily reflecting the acquired ETFS business and higher average AUM. Average global AUM was $61.3 billion, up 38.0% from $44.4 billion.
- Operating expenses rose 46.2% to $60.2 million; operating margin was approximately 19.4%, versus 26.7% a year earlier. Acquisition-related costs were $7.9 million in Q2 and $10.0 million for the first half.
- Q2 net income increased 38.2%, while pretax income was nearly flat at $22.2 million. Lower tax expense contributed to the net income increase; the effective tax rate was 24.6% versus 45.5% in Q2 2017.
- For the first half, revenue increased 22.0%, expenses increased 30.8%, operating income declined 3.1%, and net income increased 37.7%. The prior-year period included a $6.9 million Thesys settlement gain; the current period included a $9.9 million gain from revaluing the assumed gold-payment obligation.
- U.S.-listed ETF AUM ended Q2 at $41.3 billion, down from $42.9 billion at March 31, including $1.2 billion of quarterly net outflows and $0.3 billion of market depreciation. International ETP AUM rose to $18.6 billion, mainly from the acquisition, partly offset by $1.1 billion of market depreciation.
- Cash and cash equivalents were $70.7 million at June 30, versus $54.2 million at year-end. Reported available liquidity was $105.3 million, including the undrawn $50 million revolver. Current assets were $108.5 million and current liabilities $66.7 million.
- The company borrowed $200 million under a term loan to fund the acquisition; its carrying value, net of issuance costs, was $193.4 million. The loan matures April 11, 2021, bears variable LIBOR-based interest (4.92% effective rate reported), and is due in a bullet payment. No revolver borrowings were outstanding.
- The company also recorded $162.8 million of deferred consideration for contractual gold payments, including $11.4 million current and $151.5 million long-term. Stockholders’ equity was $353.3 million; separately classified Series A preferred stock had a $132.6 million carrying value.
- Operating cash flow was $9.0 million for the first half. Investing cash flow was a $172.6 million outflow, principally reflecting $233.2 million paid for ETFS net of cash acquired; financing cash flow was $181.1 million, including the term loan proceeds.
Material changes, outlook, risks, and unusual items
- Acquisition and funding: ETFS was acquired April 11 for $253 million cash and equity consideration valued at $270 million, comprising 15.25 million common shares and preferred shares convertible into 14.75 million common shares. The purchase-price allocation is preliminary; acquired advisory-agreement intangibles were valued at $601.2 million and goodwill at $84.1 million.
- Gold-related obligation: The company assumed payments of 9,500 ounces of gold annually through March 2058, then 6,333 ounces annually in perpetuity, subject to the terms described in the filing. The liability is a Level 3 fair-value estimate sensitive to projected gold prices and discount-rate assumptions. Q2 included $2.7 million of contractual gold-payment expense and a $9.9 million revaluation gain after gold prices declined.
- Leverage and restrictions: The credit agreement is secured by substantially all assets of the company and certain subsidiaries, includes leverage-ratio tests beginning September 2018, and restricts dividends and share repurchases in specified circumstances. The $0.03 quarterly dividend was in place; larger dividends and most repurchases require a leverage ratio no higher than 1.75:1 and no continuing default.
- Market and business risks: Revenue depends on ETP AUM and is exposed to market performance, investor flows, foreign exchange, interest rates, and commodity prices. Management highlighted Q2 market weakness in emerging markets and gold, and outflows from its two largest U.S. ETFs, HEDJ and DXJ. About 19% of U.S. AUM was concentrated in those two products. The acquired business increased currency and gold exposure; the company reported no current hedging of gold exposure.
- Management outlook: No specific earnings or revenue guidance was provided. Management said operating cash flows and cash balances should fund operations for at least 12 months and noted access to the revolver. Management viewed the proposed SEC ETF rule as potentially reducing launch barriers while stating industry success barriers remain. The company’s average global advisory fee declined by about 0.02 percentage points to 0.48% following the acquisition and product-mix change.
- Other developments: In July 2018, the company decided to close its Japan sales office and expand a third-party distribution relationship; the office had a $1.1 million Q2 operating loss. The company reported no litigation expected to have a material adverse impact. It is integrating ETFS controls and anticipated deferring assessment of ETFS-related internal controls; management concluded disclosure controls were effective at a reasonable assurance level.
- Tax contingency: ETFS-related uncertain tax benefits and accrued interest and penalties totaled $28.3 million at June 30, offset by an indemnification receivable from ETFS Capital. The acquired tax matter includes a review of a 2016 Jersey subsidiary return.
Important facts for investors to verify
- Whether post-acquisition AUM, flows, and operating performance support sustainable revenue growth, especially given continued outflows from HEDJ and DXJ.
- The final ETFS purchase-price allocation and the assumptions supporting the $601.2 million indefinite-lived intangible asset and $84.1 million goodwill, including future impairment assessments.
- The projected cash cost, gold-price sensitivity, and accounting treatment of the long-term gold-payment obligation.
- Debt covenant headroom, leverage compliance as testing begins, variable-rate interest exposure, and the effect of financing restrictions on dividends and repurchases.
- Potential dilution and economic rights associated with the 14.75 million shares issuable on preferred conversion, alongside the 15.25 million common shares issued in the acquisition.
- Resolution of the acquired tax exposure and the enforceability and adequacy of the ETFS Capital indemnification.