Wisdomtree, Inc. quarterly report, Q2 FY2013

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WisdomTree Investments, Inc. — Q2 2013 Form 10-Q

Reporting period: Three and six months ended June 30, 2013. Unless otherwise noted, financial amounts below are in U.S. dollars; financial statements report amounts in thousands.

Business context

WisdomTree sponsors and manages ETFs, earning primarily advisory fees based on average ETF assets under management (AUM). At quarter-end it managed 50 ETFs with $29.0 billion in AUM and was the fifth-largest U.S. ETF sponsor by AUM. It reported one business segment, with operations and assets in the United States.

Financial and operating performance

  • Q2 revenue: $37.3 million, up 83.1% year over year; ETF advisory fees were $37.1 million. Average AUM rose 87.8% to $28.4 billion, while the average advisory fee declined to 0.52% from 0.54% due mainly to product mix.
  • Q2 earnings: Net income was $12.2 million versus $0.1 million; diluted EPS was $0.09 versus approximately $0.00. Expenses rose 23.8% to $25.1 million. Management reported a 33% pre-tax operating margin, compared with 1% a year earlier.
  • First-half revenue and earnings: Revenue was $66.7 million, up 68.5%; net income was $20.1 million versus $1.2 million; diluted EPS was $0.14 versus $0.01. Expenses increased 21.5% to $46.6 million.
  • Flows and AUM: Net inflows were $5.0 billion in Q2 versus $0.3 billion in Q2 2012, and $10.9 billion for the first half versus $2.6 billion. AUM reached $29.0 billion at June 30, up 58.5% during the first half. The Japanese hedged equity ETF accounted for $4.2 billion of Q2 inflows and $8.1 billion for the first half.
  • Cash flow and liquidity: First-half operating cash flow was $29.2 million versus $8.5 million; cash increased $29.5 million to $70.7 million. At June 30, current assets were $85.2 million and current liabilities $21.7 million. Management said operating cash flows should fund operations for at least the next 12 months.
  • Capital and debt: Total liabilities were $21.7 million, consisting principally of operating payables and accrued compensation; the filing reports no debt. Investments were $11.4 million, held to maturity and primarily U.S. government and agency debt securities. Their stated fair value was $10.7 million, including $712,000 in gross unrealized losses.
  • Taxes: No income-tax provision was recorded in either comparative period. The company reported a full valuation allowance against its deferred tax asset, citing its history of tax losses.

Material changes and unusual items

  • Revenue growth principally reflected higher average AUM and strong inflows. The blended advisory fee fell to 0.52% in Q2 from 0.54%, largely because of flows into the lower-fee Japanese hedged equity ETF.
  • Expense growth reflected higher compensation and fund-related costs as AUM and inflows increased. Ending the BNY Mellon joint venture in 2012 also shifted certain currency and fixed-income ETF operating costs to WisdomTree; management attributed approximately $0.6 million of Q2 and $1.2 million of first-half cost increases to this change.
  • Comparative 2012 expenses included $3.2 million of ETF shareholder proxy costs for Q2 and $3.3 million for the first half. The 2012 periods also included patent-litigation expense/reimbursement; the patent case was settled in November 2012, and no material litigation was pending at filing.
  • Cash from financing was $0.8 million in the first half, including $1.1 million from employee option exercises and $0.2 million of share repurchases for employee tax withholding. The company received no proceeds from stock issuance in the 2013 period.

Outlook, commentary and risks

  • No formal revenue or earnings guidance was provided. Management expected Q3 marketing spending to remain at Q1–Q2 2013 levels.
  • The office lease was due to expire in January 2014; the company anticipated entering a new 16-year lease in August 2013. Management estimated an approximately $0.7 million quarterly increase in rent expense during the second half of 2013 and approximately $0.2 million per quarter in ongoing rent expense above the current level, with additional future depreciation and amortization of approximately $0.2 million per quarter.
  • Results are sensitive to market prices, currency movements, investor flows, and changes in the value of assets underlying the ETFs. Management noted volatile market conditions and stated that AUM and revenue are affected by global markets and the U.S. dollar.
  • Concentration is a significant disclosed risk: Japan-focused ETFs represented approximately 35.1% of AUM, including 34.3% in the WisdomTree Japan Hedged Equity Fund. The top ten ETFs represented approximately 81% of AUM and the top five approximately 68%.
  • The company also identified competition, product development, vendor costs, regulation, and investor sentiment as risks to its outlook. The Japan hedged-equity inflow surge creates exposure to market-specific political, economic, and currency changes.

Important facts for investors to verify

  • Whether Japan-focused inflows and the unusually high AUM concentration persist, and how any reversal would affect advisory revenue.
  • Whether market declines, foreign-exchange movements, or outflows offset continued asset gathering; assess the lower blended fee rate and product mix.
  • Whether expense growth, including compensation, fund operating costs, and the new office lease, remains controlled relative to revenue.
  • The maturity, liquidity, and valuation of the held-to-maturity investment portfolio, including the reported unrealized losses.
  • Lease terms and timing, and the actual rent and depreciation effects compared with management’s estimates.
  • The assumptions supporting the full deferred-tax-asset valuation allowance and the company’s expectation that operating cash flows will cover at least 12 months of operations.