WESTWOOD HOLDINGS GROUP INC quarterly report, Q2 FY2013

Westwood Holdings Group, Inc. — Q2 2013 Form 10-Q Summary

Reporting period: Quarterly and year-to-date periods ended June 30, 2013; comparisons are to the three and six months ended June 30, 2012 unless otherwise noted. The filing is unaudited. Westwood provides investment advisory, trust and custodial services; revenue is substantially dependent on assets under management and financial-market conditions.

Financial Highlights

Metric	Q2 2013	Q2 2012	Six months 2013	Six months 2012
Total revenue	$23.5 million	$20.1 million	$43.6 million	$37.9 million
Income before taxes	$7.7 million	$3.8 million	$12.5 million	$9.8 million
Net income	$4.9 million	$2.2 million	$7.7 million	$6.0 million
Diluted EPS	$0.65	$0.30	$1.03	$0.82
Operating cash flow	Not separately provided	Not separately provided	$9.7 million	$7.0 million

Revenue mix: Q2 asset-based advisory fees were $16.5 million, performance-based fees were $2.5 million, trust fees were $4.6 million and other revenue was a net loss of $120,000. Six-month amounts were $32.0 million, $2.5 million, $8.8 million and $216,000, respectively.
Margins: Q2 net margin was approximately 20.8% versus 11.0% in the prior-year quarter. Six-month net margin was approximately 17.7% versus 15.8%. Pre-tax margin was approximately 32.9% in Q2 and 28.6% for the first six months.
Assets under management: $15.845 billion at June 30, 2013, up 20.5% from $13.153 billion at June 30, 2012. Q2 net flows were $421 million and market appreciation was $90 million.
Liquidity: Cash and cash equivalents were $6.1 million and investments were $51.4 million at June 30, 2013. Working capital was $62.1 million.
Debt: The company reported no long-term debt and no liabilities for borrowed money.
Capital allocation: Six-month financing cash outflow was $6.9 million, including $3.0 million of cash dividends and $4.6 million of treasury-stock purchases, partially offset by $684,000 of excess tax benefits.

Material Changes Versus Prior Comparable Period

Q2 revenue increased 17%; six-month revenue increased 15%.
Q2 net income increased 122%; six-month net income increased 29%.
Q2 performance-based advisory fees more than doubled to $2.5 million. The filing indicates these fees can be volatile and are recognized at the end of measurement periods.
Other revenue declined substantially because the prior-year period included an approximately $899,000 gain on the sale of Teton shares, while 2013 included higher investment losses.
Q2 total expenses declined 4%, primarily because the prior-year period included recruiting and legal costs related to Westwood International. Six-month expenses increased 11%, largely because of higher compensation, restricted-stock expense, mutual-fund costs and operating expenses associated with the newer Canadian operation.
Employee compensation and benefits were $23.8 million for the first six months, up 14%. Stock-based compensation was $5.7 million, up from $4.8 million.
Westwood International generated $3.2 million of revenue and incurred $4.7 million of costs during the first six months. Management reported more than $1.5 billion of related assets under management at June 30, 2013.
Total stockholders’ equity increased to $79.4 million from $76.6 million at December 31, 2012, despite $6.5 million of dividends declared and $4.6 million of treasury-stock purchases.

Outlook, Risks, Contingencies and Unusual Items

Management believes existing cash, short-term investments and operating cash flow will fund ordinary operating and capital requirements for at least the next twelve months, although additional financing could be required.
No formal revenue or earnings guidance is provided in the filing. A 2013 performance-based restricted-stock goal requires adjusted pre-tax income of at least $27.0 million; management concluded that achievement was probable and began recording related expense.
Management identifies risks from market downturns, customer and revenue concentration, asset outflows, competition and fee pressure, investment-consultant and client relationships, retention of personnel, development of new strategies, tax-rate changes, regulation and internal controls.
AGF Management and AGF Investments have filed two Canadian lawsuits related to the hiring of Westwood’s investment personnel. AGF seeks unspecified damages and punitive damages, including stated claims of up to C$10 million in one action and C$5 million in the other, plus additional punitive amounts. Westwood has filed counterclaims. The ultimate financial impact cannot currently be estimated; adverse resolution could materially affect results.
Westwood expects insurance to cover 50% of defense costs for the two AGF claims, excluding the counterclaim, and recorded a $259,000 insurance receivable.
Westwood Funds and other sponsored investment vehicles are treated as variable interest entities but are not consolidated because Westwood is not the primary beneficiary. At June 30, 2013, Westwood Funds had $2.1 billion of assets under management and $12.7 million of corporate investment and risk of loss.
Management reported effective disclosure controls and procedures and no material changes in internal control over financial reporting during the quarter.

Key Facts Investors Should Verify

Whether assets under management and net flows remain durable, particularly after withdrawals and rebalancing in the LargeCap strategy.
The sustainability and timing of performance-based fees, which materially affected the quarter-over-quarter earnings increase.
The profitability trajectory of Westwood International, including whether its $4.7 million of first-half costs can be supported by future revenue.
The effect of substantial stock-based compensation, including $27.7 million of remaining unrecognized restricted-stock expense.
The status, insurance coverage and potential exposure associated with the AGF litigation.
The company’s continuing dividend and share-repurchase policy relative to operating cash generation and its $57.5 million of cash and investments.