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WHG > SEC Filings for WHG > Form 10-Q on 18-Apr-2013All Recent SEC Filings

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Form 10-Q for WESTWOOD HOLDINGS GROUP INC


18-Apr-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

Statements in this report and the Annual Report to Stockholders that are not purely historical facts, including, without limitation, statements about our expected future financial position, results of operations or cash flows, as well as other statements including, without limitation, words such as "anticipate," "believe," "plan," "estimate," "expect," "intend," "should," "could," "goal," "may," "target," "designed," "on track," "comfortable with," "optimistic" and other similar expressions, constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. Actual results and the timing of some events could differ materially from those projected in or contemplated by the forward-looking statements due to a number of factors, including, without limitation, the risks described under "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2012 filed with the SEC, and those set forth below:

• our ability to identify and market services that appeal to our customers;

• the significant concentration of our revenues in four of our customers;

• our relationships with investment consulting firms;

• our relationships with current and potential customers;

• our ability to retain qualified personnel;

• our ability to develop and market new investment strategies successfully;

• our ability to maintain our fee structure in light of competitive fee pressures;

• competition in the marketplace;

• downturns in financial markets;

• new legislation adversely affecting the financial services industries;

• interest rates;

• changes in our effective tax rate;

• our ability to maintain an effective system of internal controls; and

• other risks as detailed from time to time in our SEC reports.

You should not unduly rely on these forward-looking statements, which speak only as of the date of this report. We are not obligated and do not undertake an obligation to publicly release any revisions to these forward-looking statements to reflect events or circumstances occurring after the date of this report or to reflect the occurrence of unanticipated events or otherwise.

Overview

We manage investment assets and provide services for our clients through our subsidiaries, Westwood Management, Westwood Trust and Westwood International. Westwood Management provides investment advisory services to corporate and public retirement plans, endowments and foundations, the Westwood Funds™, other mutual funds, individuals and clients of Westwood Trust. Westwood Trust provides trust and custodial services and participation in common trust funds that it sponsors to institutions and high net worth individuals. Westwood International was established in the second quarter of 2012 and provides global equity and emerging markets investment advisory services to institutional clients, Westwood Funds™ family of mutual funds, and common trust funds sponsored by Westwood Trust. Our revenues are generally derived from fees based on a percentage of assets under management. We believe we have established a track record of delivering competitive risk-adjusted returns for our clients. On an asset-weighted basis, more than 90 percent of our investment strategies have delivered above-benchmark performance and more than 95 percent have experienced below-benchmark volatility over the past 10 years. Percentages stated in this section are rounded to the nearest whole percent.

Revenues

We derive our revenues from investment advisory fees, trust fees, and other revenues. Our advisory fees are generated by Westwood Management and Westwood International, which manage client accounts under investment advisory and subadvisory agreements. Advisory fees are calculated based on a percentage of assets under management and are paid in accordance with the terms of the agreements. Advisory fees are paid quarterly in advance based on assets under management on the last day of the preceding quarter, quarterly in arrears based on


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assets under management on the last day of the quarter just ended, or are based on a daily or monthly analysis of assets under management for the stated period. We recognize advisory fee revenues as services are rendered. A limited number of our clients have a contractual performance-based fee component in their contract, which generates additional revenues if we outperform a specified index over a specific period of time. We record revenue from performance-based fees at the end of the measurement periods. Since our advance paying clients' billing periods coincide with the calendar quarter to which such payments relate, revenue is fully recognized within the quarter and our consolidated financial statements contain no deferred advisory fee revenues.

Our trust fees are generated by Westwood Trust pursuant to trust or custodial agreements. Trust fees are separately negotiated with each client and are generally based on a percentage of assets under management. Westwood Trust also provides trust services to a small number of clients on a fixed fee basis. Most trust fees are paid quarterly in advance and are recognized as services are rendered. Since billing periods for most of Westwood Trust's advance paying clients coincide with the calendar quarter, revenue is fully recognized within the quarter and our consolidated financial statements do not contain a significant amount of deferred revenue.

Our other revenues generally consist of interest and investment income. Although we generally invest most of our cash in U.S. Treasury securities, we also invest in equity and fixed income instruments and money market funds.

Assets Under Management

Assets under management increased $1.4 billion to $15.3 billion at March 31, 2013 compared with $13.9 billion at March 31, 2012. The average of beginning and ending assets under management for the first quarter of 2013 was $14.8 billion compared to $13.5 billion for the first quarter of 2012, an increase of 9%.

The following table displays assets under management as of March 31, 2013 and 2012:

                                                                     % Change
                                          As of March 31,         March 31, 2013
                                           (in millions)               vs.
                                         2013         2012        March 31, 2012
       Institutional                   $  9,894     $  9,068                    9 %
       Private Wealth                     3,527        3,330                    6
       Mutual Funds                       1,913        1,475                   30

       Total Assets Under Management   $ 15,334     $ 13,873                   11 %

• Institutional includes separate accounts of corporate pension and profit sharing plans, public employee retirement funds, Taft Hartley plans, endowments, foundations and individuals; subadvisory relationships where Westwood provides investment management services for funds offered by other financial institutions; and managed account relationships with brokerage firms and other registered investment advisors which offer Westwood products to their customers.

• Private Wealth includes assets for which Westwood Trust provides trust and custodial services and participation in common trust funds that it sponsors to institutions and high net worth individuals pursuant to trust or agency agreements. Investment subadvisory services are provided for the common trust funds by Westwood Management, Westwood International and external, unaffiliated subadvisors. For certain assets in this category, Westwood Trust currently provides limited custody services for a minimal or no fee, but views these assets as potentially converting to fee-generating managed assets in the future. As an example, some assets in this category consist of low-basis stock currently being held in custody for clients, but we believe there is potential for these assets to convert to fee-generating managed assets during an inter-generational transfer of wealth at some future date. Also included are assets acquired in the McCarthy Group Advisors, L.L.C. transaction, described in Note 6 of the financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2012.

• Mutual Funds include the Westwood Funds™, a family of U.S.-registered mutual funds for which Westwood Management serves as advisor.


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Roll-Forward of Assets Under Management



                                                                         % Change
                                          Three Months Ended          March 31, 2013
   ($ millions)                                March 31,                   vs.
                                          2013           2012         March 31, 2012
   Institutional
   Beginning of period assets           $   9,225      $  8,735                     6 %
   Inflows                                    195           166                    17
   Outflows                                  (464 )        (745 )                 (38 )

   Net flows                                 (269 )        (579 )                 (54 )
   Market appreciation/(depreciation)         938           912                     3
   Net change                                 669           333                   101

   End of period assets                     9,894         9,068                     9

   Private Wealth
   Beginning of period assets               3,339         3,051                     9
   Inflows                                     92           155                   (41 )
   Outflows                                  (132 )        (114 )                  16

   Net flows                                  (40 )          41                  (198 )
   Market appreciation/(depreciation)         228           238                    (4 )
   Net change                                 188           279                   (33 )

   End of period assets                     3,527         3,330                     6

   Mutual Funds
   Beginning of period assets               1,603         1,293                    24
   Inflows                                    195           166                    17
   Outflows                                   (41 )         (85 )                 (52 )

   Net flows                                  154            81                    90
   Market appreciation/(depreciation)         156           101                    55
   Net change                                 310           182                    70

   End of period assets                     1,913         1,475                    30

   Total
   Beginning of period assets              14,167        13,079                     8
   Inflows                                    482           487                    (1 )
   Outflows                                  (637 )        (944 )                 (33 )

   Net flows                                 (155 )        (457 )                 (66 )
   Market appreciation/(depreciation)       1,322         1,251                     6
   Net change                               1,167           794                    47

   End of period assets                 $  15,334      $ 13,873                    11 %

Three months ended March 31, 2013 and 2012

The $1.2 billion increase in assets under management for the three months ended March 31, 2013 was due to market appreciation of $1.3 billion and inflows of $482 million, partially offset by outflows of $637 million. Inflows were primarily driven by inflows into the Westwood Income Opportunity mutual fund and inflows into institutional accounts in our Emerging Markets strategy managed by Westwood International and our SMidCap Plus+ strategy. Outflows were primarily related to rebalancing by clients from our LargeCap strategy and other strategies to a lesser degree. Our various strategies are described in our Annual Report on Form 10-K for the year ended December 31, 2012.

The $794 million increase in assets under management for the three months ended March 31, 2012 was due to market appreciation of $1.3 billion and inflows of $487 million, partially offset by outflows of $944 million. Inflows were evenly distributed into new and existing institutional separate accounts, the Westwood FundsTM and new and existing private wealth accounts. Outflows were primarily related to rebalancing by institutional separate accounts.


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Results of Operations

In the second quarter of 2012, as part of our strategy to expand our research capabilities and product offerings, we established Westwood International, based in Toronto, Canada, to manage global and emerging markets equity strategies. Westwood International began providing investment management services during the third quarter of 2012. At March 31, 2013, Westwood International had assets under management of $1.0 billion. As Westwood International has only recently commenced operations, our Consolidated Statement of Comprehensive Income for the three months ended March 31, 2013 includes $3.2 million in costs related to Westwood International's operations and revenues of $1.5 million.

The following table (dollars in thousands) and discussion of our results of operations for the three months ended March 31, 2013 is based upon data derived from the consolidated statements of comprehensive income contained in our consolidated financial statements and should be read in conjunction with those statements, included elsewhere in this report.

                                                                        % Change
                                                                   Three months ended
                                        Three months ended           March 31, 2013
                                             March 31,                    vs.
                                         2013          2012          March 31, 2012
 Revenues
 Advisory fees - asset based          $   15,547     $ 14,090                       10 %
 Trust fees                                4,217        3,471                       21
 Other revenues                              336          303                       11

 Total revenues                           20,100       17,864                       13

 Expenses
 Employee compensation and benefits       11,843        8,914                       33
 Sales and marketing                         287          212                       35
 Westwood mutual funds                       404          209                       93
 Information technology                      656          596                       10
 Professional services                     1,002          879                       14
 General and administrative                1,189          970                       23

 Total expenses                           15,381       11,780                       31

 Income before income taxes                4,719        6,084                      (22 )
 Provision for income taxes                1,886        2,299                      (18 )

 Net income                           $    2,833     $  3,785                      (25 )%

Three months ended March 31, 2013 compared to three months ended March 31, 2012

Total Revenues. Our total revenues increased by 13% to $20.1 million for the three months ended March 31, 2013 compared with $17.9 million for the three months ended March 31, 2012. Asset-based advisory fees increased by 10% to $15.5 million for the three months ended March 31, 2013 compared with $14.1 million for the three months ended March 31, 2012 as a result of increased average assets under management due to market appreciation and asset inflows from new and existing clients, partially offset by the withdrawal of assets by certain clients. Trust fees increased by 21% to $4.2 million for the three months ended March 31, 2013 compared with $3.5 million for the three months ended March 31, 2012 as a result of increased assets under management at Westwood Trust primarily due to market appreciation. Other revenues, which generally consist of interest and investment income, increased by 11% to $336,000 for the three months ended March 31, 2013 compared with $303,000 for the three months ended March 31, 2012. Other revenues increased primarily due to an increase of $56,000 in dividend income partially offset by a decrease of $27,000 in net realized and unrealized gains on investments.


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Employee Compensation and Benefits. Employee compensation and benefits costs generally consist of salaries, incentive compensation, equity-based compensation expense and benefits. Employee compensation and benefits costs increased by 33% to $11.8 million for the three months ended March 31, 2013 compared with $8.9 million for the three months ended March 31, 2012. The increase was primarily due to increases of $751,000 in expense related to amortization of multi-year bonus agreements, $742,000 in performance-based restricted stock expense, $697,000 in mutual fund incentive award expense, and $601,000 in salary expense due primarily to increased average headcount and salary increases, partially offset by a decrease of $189,000 in cash-based incentive compensation expense. During the first quarter of 2013, we concluded that it was probable that we would meet the performance goal required in order for the applicable percentage of performance-based restricted shares to vest. In 2012, we did not conclude performance-based shares would vest nor record the related expense until the second quarter. We had 96 full-time employees as of March 31, 2013 compared to 83 full-time employees as of March 31, 2012.

Sales and Marketing. Sales and marketing costs relate to our marketing efforts, including travel and entertainment, direct marketing and advertising costs. Sales and marketing costs increased by 35% to $287,000 for the three months ended March 31, 2013 compared with $212,000 for the three months ended March 31, 2012. The increase was primarily the result of increased direct marketing expenses.

Westwood Mutual Funds. Westwood Mutual Funds expenses relate to our marketing, distribution, administration and acquisition efforts related to the Westwood Funds™. Westwood Mutual Funds expenses increased 93% to $404,000 for the three months ended March 31, 2013 compared with $209,000 for the three months ended March 31, 2012. In the fourth quarter of 2012, we launched three new mutual funds, which increased our fund reimbursement costs.

Information Technology. Information technology expenses are generally costs associated with proprietary investment research tools, maintenance and support, computing hardware, software licenses, telecommunications and other related costs. Information technology costs increased by 10% to $656,000 for the three months ended March 31, 2013 compared with $596,000 for the three months ended March 31, 2012. The increase was primarily due to increased research expenses and increased equipment expenses.

Professional Services. Professional services expenses generally consist of costs associated with subadvisory fees, audit, legal and other professional services. Professional services expenses increased by 14% to $1.0 million for the three months ended March 31, 2013 compared with $879,000 for the three months ended March 31, 2012 primarily due to legal fees. These increases were partially offset by decreased financial advisory expense due to the termination of subadvisors on international common trust funds in the second quarter of 2012.

General and Administrative. General and administrative expenses generally consist of costs associated with the lease of our office space, investor relations, licenses and fees, depreciation, insurance, office supplies and other miscellaneous expenses. General and administrative expenses increased by 23% to $1.2 million for the three months ended March 31, 2013 compared with $1.0 million for the three months ended March 31, 2012. The increase was primarily due to rent expense for our new Toronto office, non-marketing travel expenses related to Westwood International and increased custody expense, partially offset by a decrease in acquisition related amortization expense.

Provision for Income Tax Expense. Provision for income tax expenses decreased by 18% to $1.9 million for the three months ended March 31, 2013 compared with $2.3 million for the three months ended March 31, 2012. The effective tax rate increased to 40.0% for the three months ended March 31, 2013 from 37.8% for the three months ended March 31, 2012 primarily due to operating losses from Westwood International, which is taxed at a lower Canadian tax rate.

Supplemental Financial Information

As supplemental information, we are providing non-U.S. generally accepted accounting principles ("non-GAAP") performance measures that we refer to as Economic Earnings and Economic Expenses. We provide these measures in addition to, but not as a substitute for, net income and total expenses, which are reported on a U.S. generally accepted accounting principles ("GAAP") basis. Both our management and Board of Directors review


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Economic Earnings and Economic Expenses to evaluate our ongoing performance, allocate resources and review dividend policy. We believe that these non-GAAP performance measures, while not substitutes for GAAP net income and total expenses, are useful for management and investors when evaluating our underlying operating and financial performance and our available resources. We do not advocate that investors consider these non-GAAP measures without considering financial information prepared in accordance with GAAP.

In calculating Economic Earnings, we add to net income the non-cash expense associated with equity-based compensation awards of restricted stock and stock options, amortization of intangible assets and the deferred taxes related to the tax-basis amortization of goodwill. We define Economic Expenses as total expenses less non-cash equity-based compensation expense and amortization of intangible assets. Although depreciation on property and equipment is a non-cash expense, we do not add it back when calculating Economic Earnings or deduct it when calculating Economic Expenses because depreciation charges represent a decline in the value of the related assets that will ultimately require replacement.

Our Economic Earnings decreased by 3% to $5.7 million for the three months ended March 31, 2013 compared with $5.8 million for the three months ended March 31, 2012, primarily due to increases in Economic Expenses.

The following tables provide a reconciliation of net income to Economic Earnings and total expenses to Economic Expenses (in thousands):

                                        Three Months Ended March 31             %
                                        2013                  2012            Change
  Net Income                        $       2,833         $       3,785           (25 )%
  Add: Restricted stock expense             2,706                 1,865            45
  Add: Intangible amortization                 90                   122           (26 )
  Add: Deferred taxes on goodwill              38                    47           (19 )

  Economic Earnings                 $       5,667         $       5,819            (3 )

  Total expenses                    $      15,381         $      11,780            31
  Less: Restricted stock expense           (2,706 )              (1,865 )          45
  Less: Intangible amortization               (90 )                (122 )         (26 )

  Economic Expenses                 $      12,585         $       9,793            29 %

Liquidity and Capital Resources

We fund our operations and cash requirements with cash generated from operating activities. As of March 31, 2013, we had no long-term debt. The changes in net cash provided by operating activities generally reflect the changes in earnings plus the effects of non-cash items and changes in working capital. Changes in working capital, especially accounts receivable and accounts payable, are generally the result of timing differences between collection of fees billed and payment of operating expenses.

During the three months ended March 31, 2013, cash flow provided by operating activities, principally our investment advisory business, was $5.3 million. At March 31, 2013, we had working capital of $58.5 million. Cash flow used in investing activities during the three months ended March 31, 2013 of $247,000 was related to the purchases of fixed assets. Cash flow used in financing activities during the three months ended March 31, 2013 of $3.0 million was due to the payment of dividends and the purchase of treasury shares partially offset by tax benefits from equity-based compensation.

We had cash and investments of $53.8 million as of March 31, 2013 and $63.7 million as of December 31, 2012. Dividends payable and accrued dividends were $4.1 million and $1.2 million as of March 31, 2013 and December 31, 2012, respectively. We had no liabilities for borrowed money at March 31, 2013.

Our future liquidity and capital requirements will depend upon numerous factors, including our results of operations, the timing and magnitude of capital expenditures or strategic initiatives, our dividend policy and other business and risk factors described under "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2012 filed with the SEC. We believe that current cash and short-term investment balances and cash


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generated from operations will be sufficient to meet the operating and capital requirements of our ordinary business operations through at least the next twelve months. However, there can be no assurance that we will not require additional financing within this time frame. The failure to raise needed capital on attractive terms, if at all, could have a material adverse effect on our business, financial condition and results of operations.

Contractual Obligations

There have been no significant changes in our contractual obligations since December 31, 2012.

Critical and Significant Accounting Policies and Estimates

There have been no significant changes in our critical or significant accounting policies and estimates since December 31, 2012.

Accounting Developments

On February 5, 2013, the Financial Accounting Standards Board ("FASB") issued new guidance on reporting amounts reclassified out of accumulated other comprehensive income. The new guidance does not change the requirements for reporting net income or other comprehensive income in the financial statements, but requires new footnote disclosures regarding the reclassification of accumulated other comprehensive income by component into net income. We do not expect this guidance to have a material effect on our financial statements.

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