Business Context and Reporting Period
Westwood Holdings Group, Inc. 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, asset mix, client flows and fee pressure. This unaudited Form 10-Q covers the three months ended March 31, 2017, with comparison to the three months ended March 31, 2016.
AUM was $22.1 billion at March 31, 2017, up 4% from $21.1 billion a year earlier. First-quarter 2017 market appreciation of $1.1 billion more than offset net outflows of $295 million.
Financial Performance and Position
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Total revenue | $32.6 million | $29.1 million | Up 12% |
| Asset-based advisory fees | $23.8 million | $21.8 million | Up 9% |
| Performance-based advisory fees | $0.4 million | None reported | Up $0.4 million |
| Trust fees | $7.8 million | $7.5 million | Up 4% |
| Total expenses | $24.9 million | $23.5 million | Up 6% |
| Income before taxes | $7.8 million | $5.6 million | Up 38% |
| Net income | $6.1 million | $3.5 million | Up 72% |
| Diluted EPS | $0.73 | $0.44 | Up 66% |
| Economic Earnings | $10.6 million | $8.1 million | Up 31% |
| Economic Earnings per diluted share | $1.28 | $1.01 | Up 27% |
Revenue growth exceeded expense growth. Net income margin was approximately 18.6%, compared with 12.1% in the prior-year quarter; pretax margin was approximately 23.8%, compared with 19.4%. The effective tax rate declined to 22.0% from 37.6%, primarily because adoption of ASU 2016-09 caused approximately $1.0 million of excess tax benefits to be recognized in income tax expense. Without that adjustment, the 2017 effective tax rate would have been 34.2%.
Employee compensation and benefits increased 7% to $17.7 million, primarily due to higher incentive compensation, merit increases and headcount growth. Stock-based compensation was $3.9 million, or approximately 12% of revenue.
| Balance-sheet item | March 31, 2017 | December 31, 2016 |
|---|---|---|
| Cash and cash equivalents | $30.6 million | $33.7 million |
| Investments at fair value | $44.8 million | $56.5 million |
| Cash and investments | $75.4 million | $90.2 million |
| Total assets | $166.1 million | $179.7 million |
| Total liabilities | $21.3 million | $33.6 million |
| Stockholders’ equity | $144.8 million | $146.1 million |
The company had no debt. Working capital was $84.9 million at March 31, 2017. Operating activities provided $9.9 million of cash, investing activities used $0.2 million, and financing activities used $13.1 million, principally for dividends and employee-related share transactions. Cash decreased $3.1 million during the quarter.
Cash dividends declared were $0.62 per share for Q1 2017, compared with $0.57 per share in Q1 2016. The board subsequently declared another $0.62 per share quarterly dividend payable July 3, 2017.
Material Changes Versus the Prior Comparable Period
- AUM increased 4% year over year, supported by market appreciation; net flows were negative in Q1 2017 compared with modestly negative flows in Q1 2016.
- Revenue increased 12%, led by higher average AUM, asset-based advisory fees and newly reported performance-based fees.
- Net income increased 72%, reflecting revenue growth, operating leverage and the lower reported tax rate.
- Economic Earnings increased 31% to $10.6 million.
- Operating cash flow declined to $9.9 million from $17.2 million, primarily reflecting lower net sales of trading investments and changes in compensation-related liabilities.
- Investments declined $11.7 million from year-end, while compensation and benefits payable declined $11.9 million.
- The company adopted ASU 2016-09 effective January 1, 2017. The adoption produced a $711,000 reduction to retained earnings related to forfeitures and affected tax expense, cash-flow classification and diluted EPS accounting.
Guidance, Outlook, Risks and Unusual Items
The filing does not provide formal revenue, earnings or AUM guidance. For performance-based restricted stock awards, management established 2017 pretax income targets of at least $24.0 million for applicable awards, with additional executive award targets ranging from threshold performance of $30.3 million to maximum performance of $42.5 million. Management concluded at quarter-end that target performance was probable.
Management expects current cash, short-term investments and operating cash flow to fund ordinary operating and capital requirements for at least the next twelve months. Westwood Trust held approximately $12.5 million above its $4.0 million minimum restricted-capital requirement.
Key risks include market and AUM volatility, net client outflows, fee and competitive pressure, customer concentration, regulatory changes, retention of investment personnel, cybersecurity and information-system risks, conflicts of interest, acquisition integration, insurance coverage and litigation.
The company continues to defend litigation brought by AGF Management Limited and AGF Investments Inc. in Canada concerning former employees and alleged inducement of breaches of obligations. Damages sought include unspecified amounts and stated punitive-damage claims. The company cannot estimate the ultimate financial impact, has not accrued a loss, and states that an adverse resolution could materially affect results. Fifty percent of defense costs for the AGF claims, excluding Westwood’s counterclaim, are covered by insurance.
Uncertain tax positions totaled $2.1 million at March 31, 2017. The company indicated that this liability could decrease by up to $2.1 million within twelve months, potentially reducing income tax expense by approximately $1.4 million.
Management reported that disclosure controls were effective and that no material changes occurred in internal control over financial reporting during the quarter.
Facts an Investor Should Verify
- Whether market appreciation continues to offset net outflows, particularly in SMidCap, Emerging Markets and LargeCap Value strategies.
- The sustainability of the Q1 tax benefit and the underlying effective tax rate excluding the $1.0 million ASU 2016-09 adjustment.
- The effect of compensation growth, stock-based compensation and performance awards on future margins and dilution.
- Cash generation after dividends, treasury-share activity and employee tax-withholding share transactions.
- The outcome and potential cost of the AGF litigation and the extent of insurance recoveries.
- Future AUM composition, fee rates, client concentration and performance-based revenue volatility.
- The company’s ability to maintain its dividend policy while preserving liquidity and meeting restricted-capital requirements.