WESTWOOD HOLDINGS GROUP INC quarterly report, Q2 FY2011

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

Business context and reporting period

Westwood manages investment assets through Westwood Management and provides trust and custodial services through Westwood Trust. Revenue is primarily based on assets under management, making results sensitive to financial-market performance, client flows and asset mix. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2011, with comparisons to the corresponding 2010 periods.

Assets under management were $13.8 billion at June 30, 2011, up 43% from $9.7 billion a year earlier. The company had 76 full-time employees versus 63 at June 30, 2010.

Financial performance and key metrics

Metric	Three months ended June 30, 2011	Three months ended June 30, 2010	Six months ended June 30, 2011	Six months ended June 30, 2010
Total revenue	$18.9 million	$13.2 million	$35.9 million	$26.4 million
Income before taxes	$5.9 million	$3.9 million	$11.5 million	$8.5 million
Net income	$3.7 million	$2.5 million	$7.3 million	$5.4 million
Basic EPS	$0.53	$0.34	$1.05	$0.74
Diluted EPS	$0.52	$0.34	$1.01	$0.74
Operating cash flow	Not separately provided	Not separately provided	$8.7 million	$8.6 million

Second-quarter revenue increased 43%, pretax income increased 50% and net income increased 50% year over year. Six-month revenue increased 36%, pretax income increased 36% and net income increased 34%.

Second-quarter revenue comprised $14.3 million of asset-based advisory fees, $991,000 of performance-based fees, $3.5 million of trust fees and $62,000 of other revenue.
Six-month asset-based advisory fees increased 36% to $27.7 million, while trust fees increased 12% to $6.8 million.
Approximate pretax margins were 31.4% for the second quarter and 32.2% for the six-month period. Net margins were approximately 19.8% and 20.3%, respectively.
Economic earnings, a non-GAAP measure, increased 30% to $6.7 million in the quarter and 28% to $12.8 million for the six months. These figures add back restricted-stock expense, intangible amortization and deferred taxes on goodwill.

Financial position, cash flow and liquidity

Cash and cash equivalents were $5.2 million at June 30, 2011, versus $1.7 million at December 31, 2010.
Investments at fair value were $44.8 million, compared with $43.3 million at year-end. Cash and investments totaled $49.9 million.
Total assets were $80.7 million and stockholders’ equity was $66.5 million at June 30, 2011.
Working capital was $51.1 million. The company reported no long-term debt and no liabilities for borrowed money.
Six-month operating cash flow was $8.7 million. Investing cash flow used $576,000, primarily for property and equipment. Financing cash flow used $4.7 million, primarily for dividends and treasury-stock purchases.
The company had a $939,000 current deferred acquisition liability and stated that it expects to pay this obligation in the fourth quarter of 2011 from operating cash flow.
Quarterly dividends were $0.35 per share; dividends payable totaled approximately $2.8 million at June 30, 2011.

Material changes versus the prior comparable period

Assets under management rose primarily from client inflows, market appreciation and assets acquired in the November 2010 McCarthy transaction. Six-month net inflows were $622 million and market appreciation was $744 million.
Performance-based advisory revenue was $991,000 in 2011 versus none in the comparable 2010 periods.
Employee compensation and benefits increased 38% in the quarter and 33% for six months, reflecting higher incentive compensation, salaries, headcount, payroll taxes and restricted-stock expense.
Total stock-based compensation expense increased to $5.2 million for six months from $4.5 million. Approximately $20.0 million of additional unrecognized restricted-stock compensation remained at June 30, 2011.
Information technology, professional services and general and administrative expenses increased materially due to system upgrades, growth initiatives, subadvisor and audit costs, amortization, additional rent and other expansion-related expenses.
The effective tax rate increased to 36.8% for both the quarter and six months, compared with 36.7% and 36.1%, respectively, primarily because of higher federal tax brackets and an additional state tax liability related to the 2010 acquisition.
The company purchased 70,834 treasury shares during the first six months, primarily to satisfy employee tax obligations related to vested restricted shares, at a total cost of $2.6 million.

Guidance, outlook, commentary, risks and unusual items

Management did not provide formal financial guidance in the filing. It 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 results, capital expenditures, strategic initiatives, dividend policy and other risks.

Revenue depends heavily on assets under management and is exposed to market declines, asset outflows and changes in client or product mix.
Other principal risks include customer concentration, competition and fee pressure, retention of qualified personnel, relationships with consultants and clients, successful development of new asset classes, regulatory or legislative changes, interest rates, tax-rate changes and internal-control effectiveness.
Performance-based restricted-stock awards resulted in additional compensation expense after management concluded the 2011 performance goal was probable of being achieved. The goal was adjusted pretax income of at least $19.3 million for 2011.
The company’s investments included $2.5 million of Level 3 available-for-sale Teton Advisors shares, valued using a quoted price less a 25% lack-of-marketability discount. Unrealized gains on these shares increased accumulated other comprehensive income by $707,000 net of tax during the first six months.
Westwood sponsors or advises unconsolidated variable-interest entities, including mutual funds and common trust funds. Management concluded it was not the primary beneficiary and reported no obligation to provide additional financial support beyond contractual commitments.
Management stated that ordinary-course legal proceedings were not expected to have a material effect on financial position, operations or cash flow. Disclosure controls were assessed as effective, with no material changes to internal control over financial reporting.

Important facts for investors to verify

Whether the substantial increase in assets under management is sustained through net inflows and market performance, particularly given exposure to concentrated customers and financial markets.
The recurring versus nonrecurring nature of the $991,000 performance-based fee and the effect of future performance fees on earnings volatility.
The impact of elevated incentive compensation, restricted-stock expense and the approximately $20.0 million remaining unrecognized equity-compensation cost.
Payment of the $939,000 deferred acquisition liability and the company’s ability to maintain dividends, share purchases and liquidity without borrowing.
Valuation and future marketability of the $2.5 million Level 3 Teton Advisors investment.
Whether expense growth from technology, professional services, mutual-fund activities and other expansion initiatives translates into sustained revenue and earnings growth.