Westwood Holdings Group, Inc. — Form 10-Q Summary
Business Context and Reporting Period
Westwood provides investment management, 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 rates and asset mix. This unaudited Form 10-Q covers the three and nine months ended September 30, 2017, compared with the corresponding 2016 periods.
AUM was $23.6 billion at September 30, 2017, up 11% from $21.3 billion a year earlier. The increase reflected market appreciation and the transfer of approximately $713 million from assets under advisement to AUM, partially offset by net outflows over the prior twelve months.
Financial Results and Key Metrics
| Metric | Three Months Ended September 30 | Nine Months Ended September 30 |
|---|---|---|
| Revenue | $33.5 million, up 5% | $99.9 million, up 9% |
| Income before taxes | $5.8 million, down 36% | $24.1 million, up 4% |
| Net income | $4.1 million, down 30% | $17.1 million, up 13% |
| Diluted EPS | $0.49, versus $0.72 | $2.05, versus $1.84 |
| Economic Earnings | $9.0 million, down 15% | $31.3 million, up 8% |
| Economic Earnings per diluted share | $1.07, versus $1.30 | $3.75, versus $3.54 |
Revenue growth was driven primarily by higher asset-based advisory fees, which increased 8% in both the quarter and year-to-date period, and higher Trust fees. Performance-based fees were $1.4 million year-to-date versus $0.6 million in 2016, but were zero in the third quarter versus $0.2 million in the prior-year quarter.
Total expenses increased 22% in the third quarter and 10% year-to-date. The third quarter included a $4.0 million net legal settlement charge, while general and administrative expense increased primarily because of foreign-currency transaction losses. Year-to-date employee compensation and benefits increased 3%, and stock-based compensation expense was $12.3 million versus $12.2 million.
Reported net margins were approximately 12.3% for the third quarter and 17.1% for the first nine months, based on reported revenue and net income. The filing does not present a separately defined operating margin.
Cash Flow, Balance Sheet, Debt and Liquidity
- Cash and cash equivalents were $51.4 million at September 30, 2017, compared with $33.7 million at December 31, 2016.
- Cash and investments totaled $99.5 million, compared with $90.2 million at year-end 2016.
- Working capital was $98.3 million, compared with $86.3 million at December 31, 2016.
- Operating cash flow was $39.4 million for the first nine months, compared with $39.0 million in 2016.
- Investing cash flow used $0.5 million, principally for property and equipment purchases.
- Financing cash flow used $23.3 million, primarily for dividends, restricted-stock tax withholding and Canadian Plan share purchases.
- The company reported no debt at September 30, 2017.
- Management believes existing cash, short-term investments and operating cash flow will meet ordinary operating and capital requirements for at least the next twelve months.
Westwood Trust held approximately $20.4 million in excess of its $4.0 million minimum restricted-capital requirement. Approximately $30 million of cash and cash equivalents represented undistributed income from Westwood International that management considers permanently invested in Canada.
Material Changes, Outlook and Unusual Items
- AGF litigation settlement: On October 13, 2017, the company settled the AGF lawsuits and related counterclaim for a one-time payment of $10 million Canadian, with approximately half expected to be covered by insurance. The company recorded a net $4.0 million charge in the third quarter, an $8.0 million settlement liability and a $4.0 million insurance receivable.
- Omaha divestiture: The company agreed to sell the Omaha-based component of its Private Wealth business. Closing was expected December 31, 2017, subject to regulatory approval, client consents and customary conditions. Expected proceeds were $7.0 million to $10.5 million. Management did not expect a material gain or loss or a material balance-sheet impact.
- Tax accounting change: Adoption of ASU 2016-09 produced a $1.0 million excess-tax-benefit adjustment in the first nine months, reducing the effective tax rate to 29.1% from 35.1% in the prior-year period. Without this adjustment, the 2017 effective rate would have been 33.0%.
- Dividend: In October 2017, the Board declared a quarterly dividend of $0.68 per share, a 10% increase from the prior quarterly rate, payable January 2, 2018.
- Goodwill: The annual third-quarter goodwill impairment assessment resulted in no impairment charge.
- Revenue standard: Management did not expect adoption of ASC 606 to materially change the timing of revenue recognition, but anticipated additional revenue disclosures.
Principal Risks and Contingencies
Key risks include changes in AUM and financial markets, net client outflows, competitive fee pressure, customer concentration, regulatory developments, competition, personnel retention, cybersecurity and information-system failures, foreign-market exposure, acquisition integration, conflicts of interest, litigation, insurance coverage, internal controls and relationships with consultants. The company also remains exposed to the risk that future capital needs could exceed available liquidity.
The company had $196,000 of recorded uncertain tax positions at September 30, 2017. It stated that this liability could decrease by as much as $196,000 within twelve months, potentially reducing income-tax expense by approximately $130,000.
Facts Investors Should Verify
- Whether the Omaha transaction closed on the expected date and the final proceeds, working-capital adjustment and impact on AUM, goodwill and intangible assets.
- The timing and amount of the AGF settlement payment and the collectability of the $4.0 million insurance receivable.
- Whether AUM growth is sustained after separating market appreciation and the $713 million AUA-to-AUM transfer from organic client flows.
- The impact of continued net outflows in selected strategies and any further fee-rate or customer-concentration pressure.
- The sustainability of dividends and share-based compensation, including the relationship between reported net income, Economic Earnings and cash generation.
- Future foreign-currency losses, particularly those related to the Canadian dollar and Westwood International.
- Management’s stated expectation that liquidity will be sufficient for at least twelve months, including any strategic, regulatory or capital-allocation changes.