WESTWOOD HOLDINGS GROUP INC quarterly report, Q3 FY2011

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

Business context and reporting period

Unaudited results cover the three and nine months ended September 30, 2011, compared with the corresponding 2010 periods. Westwood manages investment assets through Westwood Management and provides trust and custodial services through Westwood Trust. Revenue is primarily based on assets under management and is therefore sensitive to market performance, client flows, fee pressure and customer retention.

Financial performance and position

Metric	Q3 2011	Q3 2010	9M 2011	9M 2010
Total revenue	$16.0 million	$13.5 million	$51.9 million	$39.9 million
Income before taxes	$5.3 million	$4.1 million	$16.8 million	$12.6 million
Net income	$3.3 million	$2.6 million	$10.6 million	$8.0 million
Diluted EPS	$0.46	$0.38	$1.47	$1.11
Dividends declared per share	$0.35	$0.33	$1.05	$0.99

Total revenue increased 19% in Q3 and 30% for the nine-month period. Asset-based advisory fees rose 32% in Q3 and 35% for nine months; trust fees rose 22% and 15%, respectively.
Net income increased 26% in Q3 and 32% for nine months. Net income margins were approximately 20.5% and 20.4%, respectively, versus approximately 19.3% and 20.1% in the comparable periods.
The effective tax rate was 38.0% in Q3 and 37.2% for nine months, compared with 36.8% and 36.3% in 2010.
Operating cash flow was $14.3 million for the nine months, compared with $10.4 million in 2010. Investing cash flow used $1.1 million, primarily for property and equipment. Financing cash flow used $10.4 million, primarily for dividends and treasury-stock purchases.
Cash and cash equivalents were $4.6 million at September 30, 2011, and investments were $48.8 million. Combined cash and investments totaled $53.4 million.
Working capital was $51.1 million. The company reported no long-term debt or other liabilities for borrowed money.
Total assets were $84.2 million and stockholders’ equity was $66.5 million at September 30, 2011, compared with $72.6 million and $60.7 million, respectively, at December 31, 2010.
Assets under management were $11.7 billion at September 30, 2011, up 9% from $10.6 billion a year earlier. Average Q3 AUM increased 26% year over year to $12.8 billion.

Material changes versus the prior comparable period

Q3 AUM declined $2.3 billion, primarily from $2.3 billion of market depreciation and $433 million of outflows, partly offset by $504 million of inflows. For nine months, AUM declined $823 million because of $1.5 billion of market depreciation and $1.4 billion of outflows, partly offset by $2.1 billion of inflows.
Institutional AUM decreased 2% year over year to $7.8 billion, while private wealth AUM increased 45% to $2.8 billion and mutual-fund AUM increased 43% to $1.1 billion.
Other revenues changed from positive $482,000 in Q3 2010 to negative $796,000 in Q3 2011, and from positive $476,000 to negative $406,000 for nine months, primarily because of higher net unrealized investment losses.
Employee compensation and benefits increased 14% in Q3 and 26% for nine months. Full-time employees increased to 81 from 67. Total stock-based compensation expense was $7.6 million for nine months, compared with $6.9 million in 2010.
Information technology expenses increased 53% in Q3 and 54% for nine months, principally due to upgraded client-reporting and portfolio-accounting systems and research costs. General and administrative expenses increased 50% and 42%, respectively, partly due to higher rent and amortization.
The company recorded a $991,000 performance-based advisory fee for the nine months; none was recorded in the comparable 2010 period.
The board authorized a $10.0 million share-repurchase program expiring August 9, 2012. Approximately $7.0 million remained available at September 30, 2011.

Guidance, outlook, commentary, risks and unusual items

The filing does not provide formal financial guidance. Management stated that current cash, short-term investments and operating cash flow should be sufficient for ordinary operating and capital requirements through at least the next twelve months, although additional financing could become necessary.
A deferred acquisition liability is expected to be paid in the fourth quarter of 2011 using funds generated from operations. The filing does not provide a clear total amount beyond the balance-sheet liability of $773,000 at September 30, 2011.
Management identified risks from financial-market downturns, AUM volatility, customer concentration, client and consultant relationships, competition, fee pressure, retention of qualified personnel, new legislation, interest rates, tax-rate changes and internal-control effectiveness.
The company completed its annual goodwill impairment assessment in the third quarter and recorded no impairment loss.
Westwood’s unconsolidated variable-interest entities had approximately $3.0 billion of AUM at September 30, 2011, with corporate investments and reported risk of loss totaling $4.8 million. The company stated it had no obligation to provide additional financial support beyond contractual commitments.
Management concluded that disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter. Ordinary-course legal proceedings were not expected to materially affect financial position, operations or cash flow.

Important facts for investors to verify

Whether AUM market depreciation and client outflows persist and affect future fee revenue.
The concentration of revenue among four customers and the company’s ability to retain significant mandates.
The sustainability of performance-based fees, dividend payments and share repurchases relative to operating cash flow.
The effect of substantial non-cash stock compensation, including $19.1 million of remaining unrecognized restricted-stock compensation cost.
The valuation and liquidity of the $2.5 million Level 3 Teton investment and other marketable securities.
The timing and final amount of the deferred acquisition liability and any future financing needs.