Business Context and Reporting Period
Westwood Holdings Group, Inc. 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 flows, fee pressure and investment mix. This unaudited Form 10-Q covers the three and six months ended June 30, 2018, compared with the corresponding 2017 periods.
AUM was $21.6 billion at June 30, 2018, down 4% from $22.6 billion at June 30, 2017. The decrease reflected net outflows, including the Omaha private wealth divestiture, and market depreciation.
Financial Highlights
| Metric | Three Months Ended June 30, 2018 | Three Months Ended June 30, 2017 | Six Months Ended June 30, 2018 | Six Months Ended June 30, 2017 |
|---|---|---|---|---|
| Total revenue | $32.8 million | $33.8 million | $66.3 million | $66.4 million |
| Net operating income | $10.9 million | $10.6 million | $20.9 million | $18.4 million |
| Income before taxes | $10.9 million | $10.6 million | $21.4 million | $18.4 million |
| Net income | $8.0 million | $6.9 million | $16.0 million | $13.0 million |
| Diluted EPS | $0.94 | $0.83 | $1.87 | $1.56 |
| Economic Earnings | $12.2 million | $11.7 million | $24.9 million | $22.3 million |
| Economic Earnings per diluted share | $1.43 | $1.41 | $2.91 | $2.68 |
- Second-quarter revenue declined 3%, while year-to-date revenue was essentially flat. Asset-based advisory fees declined 4% in the quarter and 1% year to date; performance-based advisory fees increased 60% in the quarter and 111% year to date.
- Net income increased 16% in the quarter and 23% year to date. Approximate net margins were 24.4% and 24.1%, respectively; net operating margins were approximately 33.4% and 31.5%.
- Operating cash flow was $8.4 million for the first six months, compared with $26.8 million in 2017. The decrease primarily reflected working-capital movements, including compensation payments and purchases of trading investments.
- Investing cash flow was $4.6 million, including $10.0 million of proceeds from the Omaha divestiture and a $5.0 million strategic private-company investment. Financing cash flow was negative $18.5 million, principally due to $13.1 million of dividends paid and $4.7 million of restricted stock returned for taxes.
- Cash and cash equivalents were $47.3 million at June 30, 2018, compared with $54.2 million at December 31, 2017. Cash and short-term investments totaled $108.8 million. Working capital was $113.5 million.
- The company had no debt. Total assets were $184.3 million and stockholders’ equity was $161.1 million at June 30, 2018.
- The quarterly cash dividend was increased to $0.68 per share from $0.62 in the prior-year quarter. A $0.68 per-share dividend was declared in July 2018 for payment October 1, 2018.
Material Changes Versus the Prior Comparable Period
- Employee compensation and benefits expense decreased 6% in the second quarter and 3% year to date, partly due to the Omaha divestiture and lower incentive compensation.
- Information technology expense increased 27% in the quarter and 21% year to date due to technology infrastructure implementation and increased research expenses.
- General and administrative expense decreased 30% in the quarter and 38% year to date, primarily reflecting favorable foreign-currency effects compared with losses in 2017.
- The effective tax rate declined to 26.9% from 34.8% in the quarter and to 25.5% from 29.4% year to date, benefiting from the Tax Cuts and Jobs Act. The 2017 year-to-date comparison also included a $1.0 million discrete tax benefit.
- The Omaha-based private wealth operations sale closed January 12, 2018, generating $10.0 million of proceeds and a $524,000 gain. Goodwill declined by $7.3 million and intangible assets declined by $2.2 million as a result.
- Six-month AUM fell $2.6 billion, consisting of $2.5 billion of net outflows and $181 million of market depreciation. Institutional AUM declined 2%, private wealth AUM declined 13%, and mutual fund AUM increased 3% year over year.
- The company adopted the revenue-recognition standard under Topic 606 on January 1, 2018, using the modified retrospective method. Management reported no material adjustment to opening retained earnings.
Outlook, Risks, Contingencies and Unusual Items
- No quantitative revenue or earnings guidance was provided. Management stated that current cash and short-term investments plus operating cash generation are expected to fund ordinary operating and capital requirements for at least the next twelve months, although additional financing cannot be ruled out.
- The company committed to an additional $5.0 million purchase of equity securities in the private company by August 31, 2018. Westwood must fund any shortfall if clients, directors or employees do not purchase the full amount.
- The private-company investment was initially recorded at $5.0 million under the cost-based measurement alternative. No impairment indicators or observable price changes were identified at June 30, 2018.
- Westwood Trust is required to maintain at least $4.0 million of restricted capital and had approximately $15.5 million above that requirement at quarter-end.
- Key risks include market and AUM volatility, net client outflows, fee compression, competition, client concentration, personnel retention, regulatory changes, cybersecurity and information-system risks, operational execution, litigation, conflicts of interest, insurance coverage and third-party vendors.
- The company received insurance proceeds related to the previously settled AGF litigation during the first six months of 2018. No related receivable remained at June 30, 2018. The filing reports no current legal proceedings.
- Approximately $29 million of cash and short-term investments represented undistributed income from Westwood International and could be subject to incremental Canadian withholding taxes if repatriated.
- Management reported effective disclosure controls and no material changes to internal control over financial reporting during the quarter.
Important Facts for Investors to Verify
- Whether institutional and private wealth net outflows continue, particularly in the Emerging Markets, SMidCap and LargeCap Value strategies.
- The sustainability and timing of performance-based advisory fees, which are dependent on investment performance and can be volatile.
- Progress and funding requirements for the additional $5.0 million private-company investment, including any impairment or valuation changes.
- Whether technology investment costs and other strategic spending produce improved asset flows, operating leverage or new revenue.
- The effect of the Omaha divestiture on recurring trust and advisory revenue, expenses and future AUM comparisons.
- The final accounting impact of the Tax Cuts and Jobs Act and the outcome of the state tax audit, although management does not expect the audit to have a material impact.
- Cash generation after dividends, share-related payments and potential additional investment commitments.