Westwood Holdings Group, Inc. — Q1 2018 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 levels, investment performance, client flows and fee pressure. This unaudited quarterly report covers the three months ended March 31, 2018, with comparative results for the three months ended March 31, 2017. The company had approximately 9.0 million common shares outstanding as of April 20, 2018.
Key Financial Metrics
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Total revenue | $33.6 million | $32.6 million | 3% |
| Net operating income | $10.0 million | $7.8 million | 28% |
| Income before taxes | $10.5 million | $7.8 million | 35% |
| Net income | $8.0 million | $6.1 million | 32% |
| Diluted EPS | $0.93 | $0.73 | 27% |
| Economic Earnings | $12.6 million | $10.6 million | 19% |
| Cash flow from operations | $1.4 million | $9.9 million | Down $8.6 million |
Operating margin was approximately 29.7% in Q1 2018 versus 23.8% in Q1 2017. Net margin was approximately 23.8% versus 18.6%. The filing defines Economic Earnings as net income plus stock-based compensation, intangible amortization and the tax benefit from goodwill amortization.
- Asset-based advisory fees increased 3% to $24.5 million; performance-based fees increased to $1.3 million from $0.4 million.
- Trust fees declined 2% to $7.6 million, primarily following the Omaha Private Wealth divestiture.
- Total expenses declined 5% to $23.6 million. General and administrative expense fell 47%, while information technology expense rose 16% and Westwood mutual fund expense rose 14%.
- Cash and cash equivalents were $51.6 million at March 31, 2018, compared with $54.2 million at December 31, 2017. Cash and investments totaled $100.5 million.
- The company reported no debt. Working capital was $113.3 million at March 31, 2018.
- Total assets were $175.1 million and stockholders’ equity was $156.0 million at March 31, 2018.
- Cash dividends declared were $0.68 per share for the quarter. A subsequent $0.68 per-share dividend was declared in April 2018, payable July 2, 2018.
Material Changes Versus the Prior Comparable Period
- AUM was $22.6 billion at March 31, 2018, up 2% from $22.1 billion a year earlier, although Q1 2018 experienced $1.5 billion of net outflows and $150 million of market depreciation.
- Institutional AUM increased 8% year over year to $13.4 billion, while Private Wealth AUM declined 12% to $5.0 billion and Mutual Fund AUM increased 7% to $4.2 billion.
- The company completed the sale of its Omaha-based Private Wealth operations on January 12, 2018, receiving $10.0 million of net proceeds and recording a $0.5 million gain. The divestiture reduced goodwill by $7.3 million and intangible assets by $2.2 million.
- Operating cash flow decreased primarily because of a $13.7 million reduction in compensation and benefits payable, compared with a $11.4 million reduction in the prior-year quarter.
- Financing cash outflows were $12.7 million, including $7.3 million of dividends, $4.7 million for restricted stock returned to satisfy taxes and $0.7 million of treasury stock purchases.
- The effective tax rate was 23.9% versus 22.0%. The prior-year rate benefited from a $1.0 million discrete tax benefit; excluding that benefit, the prior-year rate would have been 34.2%.
- Accumulated other comprehensive loss increased to $3.0 million from $1.8 million, primarily due to a $1.2 million foreign currency translation loss.
Guidance, Outlook, Risks and Unusual Items
The filing does not provide formal revenue or earnings guidance. For performance-based restricted stock awards, management established 2018 income-before-tax targets, including a $20.0 million target for part of the CEO and CIO awards and a $36.0 million target for the remaining portion, with a stated range of $32.0 million to $44.5 million for threshold-to-maximum performance.
- Management expects existing cash, short-term investments and operating cash generation to fund ordinary operating and capital requirements for at least the next twelve months, while noting that additional financing could become necessary.
- Revenue and earnings remain exposed to AUM market movements, client redemptions, investment performance, fee competition, industry regulation and concentration among a small number of customers.
- Other identified risks include competition, personnel retention, cybersecurity, operational and information-system failures, third-party vendors, conflicts of interest, litigation, insurance coverage and execution of strategic initiatives.
- The company had no legal proceedings reported in Part II. The previously disclosed AGF litigation was settled in 2017 without admission of liability. During Q1 2018, the company received $3.6 million of insurance proceeds and retained an approximately $0.4 million settlement-related insurance receivable.
- The company adopted the new revenue standard effective January 1, 2018, using the modified retrospective method. Management reported no material adjustment to opening retained earnings.
- Tax accounting related to the 2017 Tax Cuts and Jobs Act remained provisional; the company expected to complete the accounting when its 2017 U.S. tax return was filed in the third quarter of 2018.
- Management concluded that disclosure controls were effective and reported no material changes in internal control over financial reporting.
Important Facts for Investors to Verify
- Whether net outflows, particularly in Institutional and Private Wealth accounts, persist and affect future fee revenue.
- The sustainability of Q1 performance-based fees and the impact of market performance on AUM and margins.
- The final tax accounting for the Tax Cuts and Jobs Act and any additional Canadian withholding tax if foreign cash is repatriated.
- The timing and collectability of the remaining insurance receivables related to the AGF settlement.
- The effect of the Omaha divestiture on recurring Trust and Private Wealth revenue, expenses and AUM.
- The ongoing magnitude of stock-based compensation, which was $4.2 million in Q1 and materially increased Economic Earnings relative to GAAP net income.
- Whether the company can sustain its dividend and capital-return activities while operating cash flow remains below net income.