WESTWOOD HOLDINGS GROUP INC quarterly report, Q3 FY2016

Westwood Holdings Group, Inc. — Form 10-Q Summary

Reporting period: Quarter and nine months ended September 30, 2016; filed October 26, 2016. Westwood provides investment management, trust and custodial services. Revenue is primarily tied to assets under management (AUM) and market performance.

Financial Performance and Position

Metric	Q3 2016	Q3 2015	9M 2016	9M 2015
Total revenue	$31.8 million	$32.5 million	$91.9 million	$99.4 million
Income before taxes	$9.1 million	$10.5 million	$23.2 million	$33.6 million
Net income	$5.9 million	$7.0 million	$15.1 million	$22.4 million
Diluted EPS	$0.72	$0.87	$1.84	$2.78
Economic Earnings	$10.6 million	$12.4 million	$29.1 million	$36.2 million
Operating cash flow	Not separately provided	Not separately provided	$39.0 million	$51.6 million

Revenue declined 2% in the quarter and 7% year to date. Asset-based advisory fees declined 6% and 11%, respectively, while trust fees declined 4% in the quarter but increased 8% year to date, primarily reflecting the Woodway acquisition.
Net income declined 16% in the quarter and 33% year to date. Net margins were approximately 18.5% in Q3 2016 versus 21.6% in Q3 2015, and 16.4% for the first nine months versus 22.6% in the prior-year period.
The effective tax rate increased to 35.0% for the quarter and 35.1% year to date, compared with 33.2% and 33.3%, respectively.
Economic Earnings, a non-GAAP measure adding back stock-based compensation, intangible amortization and deferred taxes on goodwill, declined 15% in the quarter and 20% year to date.
AUM was $21.3 billion at September 30, 2016, up 4% from $20.4 billion a year earlier. The increase reflected $1.8 billion of nine-month market appreciation, offset by $1.2 billion of net outflows. Average quarterly AUM declined year over year to $21.1 billion from $21.8 billion.
Cash and cash equivalents were $30.7 million, and investments were $49.8 million, for total cash and investments of approximately $80.5 million at September 30, 2016. Working capital was $80.2 million.
The company had no debt. Total assets were $169.7 million and stockholders’ equity was $140.9 million.
Operating cash flow funded capital needs, dividends, share repurchases and the final Woodway contingent consideration payment. Cash increased $8.0 million during the first nine months to $30.7 million.

Material Changes Versus Prior Comparable Period

Advisory revenue weakened because of lower average AUM, net outflows and prior market depreciation. Performance-based fees fell to $635,000 year to date from $2.2 million.
Trust fees increased year to date by $1.8 million, or 8%, primarily due to Woodway. Woodway contributed $7.1 million of revenue and $1.7 million of net income during the first nine months of 2016.
Total expenses increased 4% in the quarter and 5% year to date. Year-to-date information technology expense rose 48% due to new platforms, research and support costs, and Woodway; professional services expense increased 10%, including higher legal costs.
The company paid $9.3 million of final Woodway earn-out consideration during 2016, consisting of $5.6 million in cash and the remainder in common stock. The related contingent consideration liability was eliminated.
The company repurchased 117,452 shares for $5.6 million during the first nine months and had approximately $9.4 million remaining under its repurchase authorization at September 30, 2016.
Cash dividends declared were $1.71 per share year to date versus $1.50 in the prior-year period. In October 2016, the quarterly dividend was increased 9% to $0.62 per share.

Outlook, Risks, Contingencies and Unusual Items

No specific earnings or revenue guidance was provided. 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.
Key business risks include market-driven changes in AUM, net client outflows, fee pressure, competition, customer and revenue concentration, personnel retention, regulatory requirements, cybersecurity and information systems, acquisitions and integration, conflicts of interest, insurance coverage and litigation.
Westwood is defending two lawsuits brought by AGF in Canada involving former employees and alleged breaches, inducement and defamation. The company cannot estimate the ultimate financial impact; an adverse resolution could materially affect results. Approximately 50% of defense costs for the AGF claims, excluding Westwood’s counterclaim, are covered by insurance.
Uncertain tax positions totaled $2.2 million at September 30, 2016. The company stated that the liability could decrease by as much as $2.2 million within twelve months, potentially reducing income tax expense by approximately $1.4 million.
The company completed its annual goodwill impairment assessment and recorded no impairment. No intangible asset impairments were recorded.
Westwood Trust was required to maintain $4.0 million of restricted capital and had approximately $11.4 million above that minimum at September 30, 2016.
Management reported effective disclosure controls and no material changes in internal control over financial reporting.

Important Facts for Investors to Verify

Whether net outflows, particularly in institutional and named investment strategies, continue and pressure average AUM and advisory fees.
The sustainability of higher Trust revenue following the Woodway acquisition and the effect of related amortization, technology and administrative costs.
The impact of legal fees and the potential outcome and insurance recovery associated with the AGF litigation.
The resolution of uncertain tax positions and whether the potential $1.4 million tax benefit is realized.
The effect of elevated stock-based compensation, which was $12.2 million year to date, on GAAP earnings and Economic Earnings comparability.
Dividend and repurchase commitments relative to recurring operating cash flow and the company’s concentration of liquid assets in investments and cash.