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Edited Transcript of WHG earnings conference call or presentation 25-Apr-18 8:30pm GMT

Q1 2018 Westwood Holdings Group Inc Earnings Call

DALLAS Apr 26, 2018 (Thomson StreetEvents) -- Edited Transcript of Westwood Holdings Group Inc earnings conference call or presentation Wednesday, April 25, 2018 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brian O'Connor Casey

Westwood Holdings Group, Inc. - President, CEO & Director

* Julie Kramer Gerron

Westwood Holdings Group, Inc. - Senior VP, General Counsel, Chief Compliance Officer & Corporate Secretary

* Tiffany B. Kice

Westwood Holdings Group, Inc. - Senior VP, CFO & Treasurer

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Conference Call Participants

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* Macrae Sykes

Gabelli Funds, LLC - Research Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Westwood Holdings Group First Quarter 2018 Earnings Conference Call. (Operator Instructions) As a reminder, today's conference may be recorded.

I would now like to turn the call over to Ms. Julie Gerron, General Counsel and Chief Compliance Officer. Ma'am, you may begin.

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Julie Kramer Gerron, Westwood Holdings Group, Inc. - Senior VP, General Counsel, Chief Compliance Officer & Corporate Secretary [2]

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Thank you. Good afternoon, and welcome to our first quarter 2018 earnings conference call. The following discussion will include forward-looking statements, which are subject to known and unknown risks, uncertainties and other factors, which may cause actual results to be materially different from those contemplated by the forward-looking statements. Additional information concerning the factors that could cause such a difference is included in our press release issued earlier today as well as in our Form 10-Q for the quarter ended March 31, 2018, filed with the Securities and Exchange Commission. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. You are cautioned not to place undue reliance on forward-looking statements.

In addition, in accordance with the SEC rules concerning non-GAAP financial measures, the reconciliation of our economic earnings and economic earnings per share to the most comparable GAAP measures is included at the end of our press release issued earlier today.

On the call today, we have Brian Casey, our President and Chief Executive Officer; and Tiffany Kice, our Chief Financial Officer.

I will now turn the call over to our CEO, Brian Casey.

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Brian O'Connor Casey, Westwood Holdings Group, Inc. - President, CEO & Director [3]

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Thanks, Julie. We appreciate all of you taking the time to listen to our first quarter earnings call. I will begin today with comments on the investment environment during the first quarter of 2018 and then dive deeper with an update on our 3 distinct investment teams.

The beginning of the new year behaved much as it did in 2017 with low volatility associated with the euphoria over tax cuts, while internationally, we continued to experience momentum-driven markets. This changed quickly at the end of January as rising political uncertainty and inflation fears reversed market momentum, and we experienced the first corrections since early 2016.

For the remainder of the quarter, market volatility remained high, due to increased speculation of a trade war between the U.S. and its trading partners, especially with China, and we saw U.S. and international developed markets finishing lower. Emerging markets, on the other hand, saw increases in EPS growth estimates and finished higher for the quarter.

Our strategies fared well in this new volatile and uncertain environment, and we believe these forces will continue to shift the investing landscape from one driven by easy money, high correlations and a rising tide to one with real winners and real losers, where active managers with disciplined investment processes can outperform.

U.S. markets saw smaller caps beat large caps and growth beat value. The active versus passive debate will likely continue on. But we see the current environment becoming more favorable for active management than it has been in several years.

Domestically, our U.S. Value and multi-asset class products all had strong quarters across the board and outperformed their respective primary benchmarks. Our focus on absolute downside, a cornerstone of our investment process, allowed our strategies to navigate the choppy environment and add value for our clients.

Our SmallCap Value and Concentrated LargeCap products, again, had strong quarters and both produced positive returns versus declines in their respective benchmarks this quarter. Both remain highly ranked within their respective peer groups in the eVestment manager universes. SmallCap Value strategy ranks in the top decile since its 2004 inception, and Concentrated LargeCap ranks in the first percentile since its inception in 2014. We are now in our fifth year of the high conviction LargeCap Concentrated strategy and hope to complete an exceptional 5-year record later this year.

Our SMidCap strategy continues to build on its improvements of 2017 and saw strong downside protection during (inaudible) overall market decline and continued to show improvement relative to peers with strong top quartile peer rankings in 2018. Tax-efficient strategy, Select Equity, continued to post stellar performance and saw its downside capture improve as market conditions deteriorated. Demand for a well-researched, high-quality, low-turnover, tax-efficient strategy has continued to grow. And we believe Select Equity will be a cornerstone of our Private Wealth portfolios for years to come.

Our multi-asset products, Income Opportunity and Worldwide Income Opportunity, also weathered the volatility well, despite declines in MLP and REIT asset classes. Both products outperformed their benchmarks during the quarter.

The MLP space remained challenged in Q1 as regulatory setbacks hurt investor sentiment and money flowed out of the MLP sector. Our MLP strategies outperformed on a relative basis, and we believe the asset class is meaningfully undervalued with good upside potential from here.

In Global Equities, Emerging Markets outperformed the rest of the world and posted positive Q1 returns. All of our international products' benchmarks started the year in a similar fashion to 2017. They were pulled up by the lower-quality, momentum-driven leaders.

Our processes keeps us in high-quality companies with successful track records. And we were unable to keep pace early in the year. However, like our domestic strategies, as markets corrected, moved away from momentum and became more volatile, our strategies outperformed.

Overall, our Global International strategies were slightly ahead of benchmarks, while our Emerging Market strategies lagged slightly with the exception of EM SMid, which was slightly ahead. The overall economic outlook is positive for both emerging and developed markets. But we expect volatility to increase as the markets reprice the risks associated with escalating geopolitical risk and normalization of central bank policy.

In Global Convertibles, our strategies posted positive absolute returns, despite both global credit and equity markets being down in the quarter. Interestingly, the spike in volatility is actually good for convertibles as the embedded option becomes more valuable and the backup in rates contributes a little more income to the portfolio.

Our Market Neutral Income product had a chance to exhibit precisely the characteristics we hoped for during volatile days. We were generally positive on down days, and the macro tail hedges provided the stability we targeted. The yield book was short on duration and essentially immune to the increase in rates. All in all, a great quarter and an improved outlook for the asset class and particularly for the Market Neutral Income product.

Looking ahead, our investment teams remain focused on identifying quality businesses that the market has mispriced. As I mentioned last quarter, our portfolio managers are focused on risk control, and we're prepared for increased volatility and a market correction. We are pleased with our performance in the quarter and feel good about the positioning of our portfolios in the year ahead.

Turning now to sales and client service. In our institutional business, we had 2 large outflows related to our EM business. The largest outflow was our third biggest EM client, a Canadian pension plan, that terminated us at the beginning of the quarter. The gentleman who originally hired us left the firm, and his replacement brought in a new EM manager. The silver lining is that the gentleman who left has reached out to talk to us about potentially hiring us for the fund lineup at his new firm.

The second largest outflow was from our biggest EM client, but that was simply a rebalancing back to target after more than a 30% return last year. Together, these 2 outflows were over $800 million. We have no reason to believe that outflows in EM will continue, as we have been out visiting our clients, and they're pleased with the thoughtful, well-researched portfolio we're managing for them.

For new business opportunities for EM, we're seeing a pickup in ratings from several consultants, due to the settlement of litigation last fall. This is a big positive for us with some of the larger consultant firms. And we're in the final stages of 2 searches and have some on-site due diligence meetings scheduled in Toronto later this month.

As for domestic strategies, we continue to see positive flows in our SmallCap strategy. We added new mandates in the subadvisory and institutional space this quarter and continue to see inflows from existing clients and strong interest from consultants and prospects. We were selected by a high-profile brand for a subadvisory mandate, which has not yet been announced publicly that should fund later this quarter.

As I stated earlier, our high-conviction LargeCap Concentrated product is in its fifth year of performance, and we are in the first percentile of our peer group since inception. We are actively talking to prospects and hope to find a partner who desires a top-performing scalable product for distribution.

Our subadvisory mandate with Aviva continues to grow as they expand their global footprint of distribution professionals. Our team has traveled extensively with the Aviva sales team during the first quarter and have had some great meetings. We feel very good about flows for the balance of the year and remain hopeful that some of the new markets that Aviva is attacking result in new flows for our global converts and Absolute Return products.

In our mutual funds business, we're pleased to report that we had positive flows for the first quarter with good additions to Income Opportunity and SmallCap. Our SmallCap mutual fund, WHGSX, is earning more attention among advisers and taking share from low performers as we replaced them in the advisers' models. We have 2 funds reaching a 3-year milestone next month, the first being the Worldwide Income Opportunity fund, which is run the same way as our flagship Income Opportunity fund only using Global Securities. We've already received a few calls on the strategy from as far away as Asia.

We also will reach 3 years with our Market Neutral Income fund. The strategy is differentiated and has had great performance. We're excited to see where these strategies will go over the years ahead.

Our strategy over a decade ago to produce institutional quality mutual funds at or below the industry average fee levels, is proving to be right on point, as the mutual fund industry punishes higher-fee funds and the platforms consolidate their funds lineup. We recognize the competitive landscape our funds are involved in, and we're committed to developing products that we believe will be in demand for years to come.

Private Wealth front, our newly remodeled Houston office is very active. We have the best pipeline we've ever had and the tax law changes have prompted more planning opportunities. We had our first foundation and endowment win since starting our foundation and philanthropy focus. Our advisory board is meeting quarterly and generating referrals for us. We've done a number of events that have yielded more flows from existing customers and new prospective customers. Houston is alive and well, and the team is doing a great job.

In Dallas, we've expanded our array of services to existing customers with new financial planning capabilities and created a new revenue source with the addition of our partnership with TD Ameritrade known as AdvisorDirect. There are only about a dozen advisers in Texas on the AdvisorDirect platform, and we were selected for inclusion in late January. We can call on TD offices in Dallas, Houston and Austin, and we'll have even more offices to call on when the Scottrade acquisition is fully integrated into TD. We are educating the adviser community about Westwood and have already picked up a few new clients with several more in the pipeline.

We are building our brand with new thought leadership pieces and product pieces that you'll see on our website, on LinkedIn or elsewhere in social media. We are implementing a digital backbone for our business over the next 2 years and have partnered with a company called InvestCloud. They have a digital modular system and client portal that we believe to be one of the best in the industry. We're excited about the opportunity to provide easily accessible and fully customizable solutions for our clients.

In closing, we just celebrated our 35th year in business. And I feel fortunate to work alongside a terrific group of colleagues and to serve a diverse and sophisticated group of long-term clients. We strive to maintain an entrepreneurial culture that allows us to try new things and to evolve to meet the ever-changing demands of the industry. I also want to thank our many loyal, long-term shareholders for taking this journey with us.

I will now turn the call over to Tiffany Kice, our CFO.

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Tiffany B. Kice, Westwood Holdings Group, Inc. - Senior VP, CFO & Treasurer [4]

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Thanks, Brian, and good afternoon, everyone. Today, we reported total revenues of $33.6 million for the first quarter of 2018 compared to $32.6 million in the prior year's first quarter and $33.9 million in the fourth quarter of 2017. The increase from the prior year quarter primarily related to performance-based fees of $1.3 million earned in the current quarter, while decrease from the immediately preceding quarter was primarily due to net outflows during the current quarter, partially offset by the performance-based fees earned in the current quarter.

As previously announced, we closed on the sale of our Omaha-based Private Wealth operations in January. We received net proceeds of $10 million and recorded $500,000 gain on the sale.

The first quarter net income of $8 million or $0.93 per share compared to $6.1 million or $0.73 per share in the prior year first quarter. And it primarily related to higher revenues and a $900,000 foreign currency transaction gain net of tax recorded in the current quarter.

First quarter net income of $8 million or $0.93 per share compared to $2.9 million or $0.34 per share in the fourth quarter of 2017, primarily due to $3.4 million incremental income tax expense recorded during the fourth quarter of 2017 as a result of tax reform enacted in December 2017 as well as the current quarter foreign currency transaction gain previously mentioned.

Economic earnings, a non-GAAP metric, was $12.6 million or $1.48 per share compared to $10.6 million or $1.28 per share in the prior year first quarter and $7.6 million or $0.89 per share in the fourth quarter of 2017.

Firm-wide assets under management totaled $22.6 billion at quarter-end and consisted of institutional assets of $13.4 billion or 59% of the total, Private Wealth assets of $5 billion or 22% of the total and mutual fund assets of $4.2 billion or 19% of the total. We experienced market depreciation of $150 million for the quarter and net outflows relating to ongoing business of $1 billion with the remaining outflows related to the sale of our Omaha-based Private Wealth operations.

Our financial position continues to be very solid with cash and investments at quarter-end totaling $100.5 million and a debt-free balance sheet. We continue to evaluate the impact of tax legislation on our fiscal 2018 results and have no significant update since our last earnings call. However, we have increased our expected fiscal 2018 effective tax rate to be in the range of 26% to 28% as we realized a lower excess tax benefit on vested shares than originally expected.

We are pleased to announce that our Board of Directors approved a quarterly cash dividend of $0.68 per share, payable on July 2, 2018, to stockholders of record on June 8, 2018. This represents an annualized dividend yield of 4.6% as of the closing price on April 23.

That brings our prepared comments to a close. We encourage you to review our investor presentation we've posted on our website reflecting first quarter 2018 highlights as well as a discussion of our business, product development and longer-term trends in revenues, earnings and dividends. We thank you for your interest in our company, and we'll open the lines to questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from the line of Mac Sykes with Gabelli.

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Macrae Sykes, Gabelli Funds, LLC - Research Analyst [2]

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I had 2 questions. First is one technical. When we think about the outlook, pipeline, searches, et cetera for EM, should we think about that on the level as the amount of outflow in 1Q?

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Brian O'Connor Casey, Westwood Holdings Group, Inc. - President, CEO & Director [3]

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Okay. No. I don't think you should look at it along the lines of the outflow. The outflow was very isolated with respect to one disappointment, which was the client that terminated us. And the second one was simply a rebalancing from our biggest client. They had over $1 billion with us and they rebalanced back to target after a 30% return. Actually, the search activity in EM is very good right now. We have -- our ratings have improved after we settled our litigation last fall. We've got lot more interest from some consultants that wouldn't use us before. And as I said, we got a couple of on-sites coming up that are sizable in terms of what they could potentially bring to EM.

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Macrae Sykes, Gabelli Funds, LLC - Research Analyst [4]

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Okay. I was just trying to sort of the size of the opportunity. It sounds like it was -- you would be less than what the outflows were in 1Q. Is that correct?

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Brian O'Connor Casey, Westwood Holdings Group, Inc. - President, CEO & Director [5]

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No. If that's what it sounded like, that's not what I meant. I think -- first of all, a couple of things. As I said in my prepared remarks, the person that hired us on the piece of business that left has gone to another pension plan. The pension plan is similar in size, and we are in active discussions currently. As for what the allocation could be, it could be exactly what we lost, it could be more, it could be less. We don't know at this point. As far as other opportunities in EM, we have a number of searches that are well over $100 million in size. And they -- usually what they do is they ask you what your fees would be on $100 million, and you have no idea what the size of the opportunity is until you get a little further down the process.

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Macrae Sykes, Gabelli Funds, LLC - Research Analyst [6]

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Understood. And then you've been pretty focused on making technology investments over the last few years. Can you talk about where you expect to see benefits, both in the short and long-term? And then how do you think about these investments impacting your overall competitive positioning?

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Brian O'Connor Casey, Westwood Holdings Group, Inc. - President, CEO & Director [7]

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Thanks, Mac. That's a great question. We have spent a lot of time and energy on technology the last couple of years. We've moved our entire operation, infrastructure to the Microsoft Azure platform. So everything we have is in the cloud, which makes us much more secure. It makes it much easier when we hire somebody or we start a new office. You can plug and play and access all of your information through that, that type of structure. Last year, we moved everything to Bloomberg, so that our front office trading system is all on Bloomberg. We're in the process in partnering with InvestCloud to replace our portfolio accounting, reconciliation and performance system with a completely digital offering. And what that means for us is that we will be much more efficient. We will have -- we will be much more accessible. The client statements and their ability to get their information will be 100 times better than it is today. You will be able to access it through your phone, through your iPad, you will be able to customize your statement and see it in the way that you want to see it. The next thing we'll be doing next year is working on our Trust accounting system. And what we hope to have by the end of 2019, early 2020 is that you'll have a completely digital experience when you access Westwood, and it will be far superior to what we have now.

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Operator [8]

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(Operator Instructions) I'm showing no further questions at this time. I would now like to turn the call back to Mr. Brian Casey for closing remarks.

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Brian O'Connor Casey, Westwood Holdings Group, Inc. - President, CEO & Director [9]

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Great. Well, thank you, Chelsea, and thank you, all, for listening to our call today. If you have any follow-up questions, feel free to call me or Tiffany directly. Visit our website at westwoodgroup.com. You can also follow us on Twitter @westwoodgroup or you can follow us on LinkedIn, where we're starting to put a lot more thought leadership pieces that you might enjoy reading. So thanks for your time. We appreciate it. And thanks for being a shareholder of Westwood.

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Operator [10]

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Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.