Westwood Holdings Group, Inc. — 2019 Third-Quarter Form 10-Q
Business context and reporting period
Westwood provides investment management, advisory, trust and custodial services to institutional investors, high-net-worth individuals and financial intermediaries. Revenue is primarily based on assets under management (AUM). This unaudited quarterly report covers the three and nine months ended September 30, 2019, compared with the corresponding 2018 periods.
AUM was $15.0 billion at September 30, 2019, down 28% from $20.8 billion at September 30, 2018. The decline reflected net client outflows, partially offset by market appreciation.
Key financial metrics
| Metric | Three months ended September 30 | Nine months ended September 30 |
|---|---|---|
| Total revenue | $19.9 million, down 33% | $65.5 million, down 32% |
| Net operating income | $1.5 million, down 79% | $5.6 million, down 80% |
| Net income | $1.1 million, down 79% | $3.4 million, down 84% |
| Diluted EPS | $0.13 | $0.40 |
| Economic Earnings | $3.9 million, down 59% | $12.8 million, down 63% |
| Economic Earnings per diluted share | $0.46 | $1.51 |
| Operating margin | Approximately 7.7% | Approximately 8.6% |
| Net margin | Approximately 5.6% | Approximately 5.1% |
Asset-based advisory fees declined 40% in the quarter and 37% year to date, primarily because of lower average AUM. Trust fees declined 13% in both periods. Performance-based fees were $154,000 in the quarter and $454,000 year to date, compared with none and $3.0 million, respectively, in the prior-year periods.
Operating expenses declined 19% in the quarter and 12% year to date, including lower employee compensation, professional services, information technology and mutual fund expenses. Stock-based compensation was $2.2 million in the quarter and $7.9 million year to date.
Cash flow, balance sheet, debt and liquidity
- Cash provided by operating activities was $33.6 million for the first nine months of 2019, compared with $15.1 million in 2018. The 2019 amount included a $23.4 million liquidation of trading investments and was partly offset by an $8.1 million decrease in compensation and benefits payable.
- Investing activities used $4.1 million, primarily for private equity and other investment purchases. Financing activities used $24.6 million, primarily for dividends, treasury-stock purchases and restricted-stock tax withholding.
- Cash and cash equivalents were $58.4 million at September 30, 2019, compared with $52.4 million at December 31, 2018. Cash and short-term investments totaled $101.2 million, compared with $118.2 million at year-end 2018.
- The company had no debt at either September 30, 2019 or December 31, 2018. Working capital was $99.7 million at September 30, 2019, compared with $112.6 million at year-end 2018.
- Westwood Trust held approximately $22.1 million above its $4.0 million minimum restricted-capital requirement.
- Management stated that existing cash, short-term investments and operating cash flow should be sufficient for ordinary operating and capital requirements for at least the next twelve months, while noting that additional financing could become necessary depending on business conditions.
Material changes versus the prior comparable period
- AUM fell $5.8 billion year over year to $15.0 billion. Institutional AUM declined 30%, wealth-management AUM declined 10% and mutual-fund AUM declined 42%.
- For the quarter, AUM decreased $402 million, consisting of $591 million of net outflows partly offset by $189 million of market appreciation. For the first nine months, AUM decreased $1.6 billion, consisting of $3.8 billion of net outflows partly offset by $2.2 billion of market appreciation.
- Quarterly revenue declined $10.0 million, while expenses declined $4.3 million; the resulting operating leverage caused operating income and net income to fall substantially.
- The effective tax rate increased to 28.4% for the quarter from 24.9% and to 41.0% year to date from 25.3%. The year-to-date rate included a $638,000 discrete tax expense related to restricted-stock compensation and was also affected by compensation-deductibility limitations.
- The company adopted the lease accounting standard effective January 1, 2019, recognizing $7.9 million of operating lease right-of-use assets and $9.7 million of lease liabilities at September 30, 2019.
- In September 2019, the company invested $2.8 million in Charis Holdings, the parent of Westwood Private Bank, and recognized $33,000 of related sublease income in the quarter.
- The company repurchased $1.3 million of stock under its repurchase program during the first nine months, with approximately $4.1 million remaining available at September 30, 2019.
Outlook, commentary, risks and unusual items
The filing does not provide numerical revenue or earnings guidance. Management emphasized that results depend heavily on AUM levels, asset composition, financial-market performance, client flows and fee rates. The company identified risks related to net outflows, market volatility, competition and fee pressure, regulation, personnel retention, cybersecurity, information systems, operational execution, third-party vendors, litigation, conflicts of interest, insurance coverage, internal controls and customer concentration.
The company recorded no goodwill or intangible-asset impairment in the quarter or year to date. The 2018 comparison includes a $524,000 gain on the sale of the Omaha-based wealth-management operations; no comparable gain was recorded in 2019. Foreign-currency results also differed materially: the company recorded a $402,000 gain in the third quarter but a $1.1 million loss year to date.
In October 2019, the board declared a quarterly dividend of $0.72 per share payable January 2, 2020. The company also repurchased 42,171 additional shares for approximately $1.2 million in October 2019.
Management reported no legal proceedings, no material changes in contractual obligations outside the ordinary course, and effective disclosure controls as of September 30, 2019.
Important facts for investors to verify
- Whether net client outflows, particularly in Income Opportunity, Emerging Markets, LargeCap Value and SMidCap strategies, continue and whether AUM stabilizes.
- The sustainability of operating cash flow, given that a substantial portion of 2019 operating cash flow came from liquidating trading investments.
- The impact of lower AUM and performance-based fees on future revenue, margins and dividend capacity.
- The tax-rate outlook, including the effects of restricted-stock compensation and compensation-deductibility limitations.
- The valuation and potential impairment risk of the company’s private-company, private-equity and related investments.
- The remaining authorization and pace of treasury-stock repurchases, as well as future dividend declarations.
- The company’s ability to maintain liquidity without repatriating approximately $32 million of undistributed Canadian income, which could incur a 5% withholding tax.