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WETF > SEC Filings for WETF > Form 10-Q on 8-Nov-2012All Recent SEC Filings




Quarterly Report


The following discussion and analysis of our financial condition and results of operations should be read together with our consolidated financial statements and the related notes and the other financial information included elsewhere in this Report. In addition to historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below. For a more complete description of the risks noted above and other risks that could cause our actual results to materially differ from our current expectations, please see the Item 1A. "Risk Factors" of our Annual Report on Form 10-K for the fiscal year ended December 31, 2011. We assume no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise, unless required by law.

Our Business

We are the seventh largest sponsor of ETFs in the United States based on assets under management ("AUM"), with AUM of approximately $16.8 billion as of September 30, 2012. An ETF is an investment fund that holds securities such as stocks or bonds and trades at approximately the same price as the net asset value of its underlying assets. ETFs offer exposure to a wide variety of investment themes, including domestic, international and emerging market equities, fixed income securities, currencies or commodities, as well as securities in specific industries and countries. We currently offer a comprehensive family of 49 ETFs, which includes 35 international and domestic equity ETFs, seven currency ETFs, five international fixed income ETFs and two alternative strategy ETFs.

Through our operating subsidiary, we provide investment advisory and other management services to the WisdomTree ETFs. In exchange for providing these services, we receive advisory fee revenues based on a percentage of the ETFs' average daily net assets under management.

Our expenses are predominantly related to selling, operating and marketing our ETFs. We have contracted with third parties to provide certain operational services for the ETFs including sub-advisory, portfolio management services, fund administration, custody, accounting and other related services for the WisdomTree ETFs.

We distribute our ETFs through all major channels within the asset management industry, including brokerage firms, registered investment advisors, institutional investors, private wealth managers and discount brokers. We target our ETFs for sale principally to the financial or investment advisor who acts as the intermediary between the end-client and us.

Our revenues are highly correlated to the level and relative mix of our AUM, as well as the fee rate associated with our ETFs. While our AUM has increased on an annual basis, we have experienced fluctuations on a quarterly basis due to changes in net inflows and, most significantly, market movement. A significant portion of our AUM is invested in securities issued outside of the United States, in particular emerging market countries. Accordingly, our AUM and our revenues are affected by movements in global capital market levels, investor sentiment towards emerging markets and the strengthening or weakening of the U.S. dollar against other currencies. It is our belief that our ability to generate inflows into our ETFs, coupled with general stock market trends, will have the greatest impact on our business.

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Market Environment

We have been and continue to operate in a challenging economic environment. Equity markets worldwide experienced positive results for the first nine months of 2012 with the S&P 500, MSCI EAFE and MSCI Emerging Market indexes increasing 16%, 10% and 12%, respectively. However, the markets have fluctuated on a quarterly basis due to general concerns over European banks and sovereign debt, inflation or economic slowdown in emerging market countries, and the unemployment rate and pace of economic recovery in the U.S. The following charts reflect the returns for three broad based equity market indexes:

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Investors have favored U.S. fixed income products due to the perceived safety of these instruments given the current economic environment. As the charts below illustrate, mutual funds and ETFs experienced inflows in fixed income products; however, mutual funds continue to experience outflows in equities and ETFs continue to experience inflows. Since we launched our ETFs in June 2006, fixed income mutual funds have experienced $1.1 trillion of inflows while equity mutual funds have experienced $350 billion of outflows. Over that same time period, fixed income ETFs have experienced $200 billion of inflows and most importantly, equity ETFs experienced $600 billion of inflows, unlike mutual funds which have experienced outflows. In fact, over the last five years, ETF inflows have represented 50% of the combined flows into mutual fund and ETF products. We believe this increasing trend will continue due to the inherent benefits of ETFs-transparency, liquidity and tax efficiency.

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Our Results

Despite the challenging markets, our AUM increased 37.8% during the first nine months of 2012, from $12.2 billion at December 31, 2011 to $16.8 billion at September 30, 2012 primarily due to $3.7 billion in net inflows we generated during the first nine months of 2012. However, our AUM and net inflow levels have fluctuated during the year primarily based on market conditions. We generated $2.3 billion of net inflows during the first quarter of 2012, a record since we started our operations in June 2006. We also experienced $1.2 billion of positive market movement due to favorable market conditions for equity securities. However, in the second quarter of 2012, we only generated $0.3 billion of net inflows and suffered $1.0 billion of negative market movement due to unfavorable market sentiment to equities as well as the fact that investors favored U.S fixed income products, a category in which we do not currently offer ETFs. In the third quarter, our net inflows rebounded to $1.0 billion and we experienced $0.7 billion of positive market movement as investors again favored equity investments. During the year, ETFs using our dividend based strategies in equities, in particular emerging market equities, along with emerging market fixed income ETFs continue to lead our net inflows.

Our market share of industry inflows during the first nine months of 2012 was 2.8% as compared to 4.3% in the same period last year. Our market share has also fluctuated during 2012 starting at 4.3% in the first quarter, declining to 1.6% in the second quarter and increasing to 1.8% in the third quarter. Positive market sentiment for equity investments contributed to our strong market share in the first quarter. The decline in the second quarter was primarily due to the fact that we do not offer U.S. fixed income ETFs, an asset class favored by investors in the second quarter and currently. Equity markets were in favor in the third quarter; however, our market share did not increase significantly due to outflows we experienced in Japanese equities and lagging inflows in European equities.

Despite these challenges, we experienced growing top line results. We recorded ETF revenues of $21.4 million in the third quarter of 2012 and $60.6 million for the first nine months of 2012 as compared to $17.6 million in the third quarter of 2011 and $48.3 million in the first nine months of 2011 primarily due to an increase in our average AUM, the measure by which our revenues are based.

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ETF Industry Developments

Price Competition in Market Capitalization Weighted Index ETFs

There has been significant price competition in certain broad based market capitalization weighted index ETFs sponsored by Charles Schwab, Vanguard and BlackRock's iShares. We believe one of our key competitive strengths is that our equity ETFs are based on our own fundamentally weighted index methodology, not market capitalization weighted indexes provided by third parties such as MSCI, S&P Dow Jones or FTSE. This key competitive strength is apparent when comparing the after fee performance of our equity ETFs against their competitive market capitalization weighted indexes, which do not charge a fee. 74% of the $14.1 billion invested in our 35 equity ETFs on September 30, 2012 were in funds that, since their respective inceptions, outperformed their market capitalization-weighted or competitive benchmarks through that date. In addition, 66%, or 23 of our 35 equity ETFs, outperformed their market capitalization-weighted or competitive benchmarks since their respective inception through September 30, 2012. That is, even after fees, we believe our fundamentally weighted approach can provide investors with better risk-adjusted returns over the long term. We believe our approach differentiates us from our competitors and helps to shield us from the intense price competition occurring in broad based market capitalization weighted index ETFs.

Other Matters

Patent Litigation

On December 1, 2011, Research Affiliates, LLC filed suit against us in the United States District Court for the Central District of California, alleging that the fundamentally weighted investment methodology we employ infringes three of plaintiff's patents, and seeking both unspecified monetary damages in an amount to be determined and an injunction to prevent further infringement.

On November 7, 2012, Research Affiliates, LLC agreed to withdraw its patent infringement suit against us and we agreed to withdraw our counterclaims and entered into a settlement agreement. Under the settlement, all parties will exchange releases for all existing claims. The other material terms of the settlement are as follows:

Research Affiliates has agreed not to sue WisdomTree for any future claims arising under any current patents held by Research Affiliates, as well as any future patents relating to fundamentally-weighted indexes and strategies that may issue under existing or future patent applications that may be filed by Research Affiliates within the next eight years, subject to reduction by up to three years if Research Affiliates is acquired. The covenant not to sue extends to service providers and customers of WisdomTree in connection with WisdomTree's products and services.

WisdomTree has agreed not to sue Research Affiliates for any future claims arising under any current patents held by WisdomTree, as well as any future patents relating to fundamentally-weighted indexes and strategies that may issue under existing or future patent applications that may be filed by WisdomTree within the next eight years, subject to reduction by up to three years if WisdomTree is acquired. The covenant not to sue extends to service providers and customers of Research Affiliates in connection with Research Affiliates' products and services.

Research Affiliates and WisdomTree have agreed that the covenants not to sue do not include a right under each party's patents to copy the other party's methodologies. They have further agreed that it is not copying if Research Affiliates introduces an index or strategy that uses at least three fundamental factors to weight its indexes and they are not predominantly dividend- or earnings-weighted, or WisdomTree introduces an index or strategy that is weighted by less than three fundamental factors.

The parties have also agreed not to challenge the other party's patents or patent applications.

Research Affiliates has agreed to a one-time payment of $0.7 million to WisdomTree. WisdomTree and the other defendants are not required to make any current or future payments to Research Affiliates.

All other terms of the settlement are confidential and the settlement will not affect the current methodologies and fees for WisdomTree ETFs.

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Our insurance carrier agreed to fund a significant majority of the cost of defending this patent infringement lawsuit, subject to a $0.3 million deductible and a reservation of rights. As of September 30, 2012, we incurred $2.9 million of legal defense and other associated costs and our insurance carrier has agreed to reimburse us $2.3 million leading to a net amount of $0.7 million in net costs we incurred during 2012.

Expiration of Joint Venture with BNY Mellon

In 2008, we entered into a mutual participation agreement with Mellon Capital Management Corporation and The Dreyfus Corporation, wholly owned by Bank of New York Mellon (BNY Mellon), in which we agreed to collaborate in developing currency and fixed income ETFs under the WisdomTree Trust. Under the agreement, we contributed our expertise in operating the ETFs, sales, marketing and research, and BNY Mellon contributed sub-advisory, fund administration and accounting services for these collaborated ETFs. All third-party costs and profits and losses are shared equally. This agreement was to expire in March 2013.

On October 25, 2012, we agreed to the early expiration of this agreement, which will now end on December 31, 2012 and entered into a new fee arrangement with BNY Mellon effective January 1, 2013. Under the new arrangement, BNY Mellon will continue to serve as portfolio manager to these ETFs under more traditional sub-advisory economic terms, which is expected to result in improved gross margins on these ETFs at current asset levels.

ETF shareholder proxy solicitation

In the second quarter of 2012, we initiated the solicitation of proxies from the WisdomTree ETF shareholders to obtain approval for us to continue as investment advisor for the WisdomTree ETFs if our largest stockholder, Michael Steinhardt, who beneficially owns 25.1% of our common stock, were to sell or otherwise transfer shares of our common stock resulting in his beneficial ownership falling below 25%. The Investment Company Act presumes a change in control of our Company if Mr. Steinhardt's ownership falls below the 25% threshold, which would trigger an automatic termination of our investment advisory agreements with the WisdomTree Trust and require approval of the WisdomTree ETF shareholders to continue the agreements. Thus, this pre-approval eliminates the need for further shareholder action. We also obtained approval from the WisdomTree ETF shareholders to allow us to change sub-advisors in the future from BNY-Mellon. We completed the proxy and obtained all the votes needed in August 2012. We incurred $3.2 million in proxy related expenses during the first nine months of 2012.

Future Outlook on Certain Expenses

We expect to have changes in certain of our expenses as follows:

Compensation and benefits - we grant equity awards to our employees as part of their total compensation. Our executive management and Board of Directors believe very strongly that equity awards are an important part of our employees' overall compensation package and that incentivizing our employees with equity in the Company aligns the interest of our employees with that of our stockholders. In January 2009, the Company's Compensation Committee and Board of the Directors approved a proposal to provide eligible employees an opportunity to exercise their underwater stock options in the future at an alternative lower strike price of $1.07. To obtain the full benefit of the alternative strike price, employees are required to remain with the Company for an additional 4 years or through February 2013. In light of the fact that the majority of our employees will have significantly vested in their equity awards very shortly, we have been working with our Compensation Committee and an independent compensation consultant to create a new equity compensation program. It is anticipated that this new program will increase our stock based compensation expense in 2013 and future periods.

Gross margin - Our gross margin is defined as our total revenues less our fund management and administration expenses and less third party sharing arrangements. As a result of terminating our current joint venture with BNY Mellon for our currency and select fixed income ETFs at the end of 2012 and beginning a new fee arrangement with BNY Mellon effective January 1, 2013, we expect to decrease our operating costs for these ETFs, which will have the affect of increasing our overall gross margins. We expect our gross margins to be between 70-75% in the near term based on current asset levels and mix.

Professional fees - Included in professional fees is stock based compensation related to restricted stock or option awards we granted to senior advisers to our Board of Directors. Under generally accepted accounting principles, these awards are considered variable expenses and are re-measured each reporting period with a corresponding impact to stockholders' equity. As such, this expense may fluctuate based upon the market price of our common stock. For the nine months ended September 30, 2012, we incurred $2.0 million in expenses related to these awards. As a result of renegotiating this arrangement on a going forward basis, we do not expect to have any variable stock based compensation after December 2012.

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Key Operating Statistics

The following table presents key operating statistics that serve as indicators
for the performance of our business:

                                                              Three Months Ended                                     Nine Months Ended
                                             September 30,         June 30,          September 30,          September 30,          September 30,
                                                 2012                2012                2011                   2012                   2011
Total ETFs (in millions)
Beginning of period assets                  $        15,004        $  15,691        $        12,934        $        12,182        $         9,891
Inflows/(outflows)                                    1,036              338                    179                  3,673                  3,142
Market appreciation/(depreciation)                      743           (1,025 )               (1,929 )                  928                 (1,849 )

End of period assets                        $        16,783        $  15,004        $        11,184        $        16,783        $        11,184

Average assets during the period            $        15,769        $  15,116        $        12,762        $        15,051        $        11,706

ETF Industry and Market Share (in
ETF industry net inflows                    $          58.4        $    20.7        $          20.9        $         132.3        $          73.7
WisdomTree market share of industry
inflows                                                 1.8 %            1.6 %                  0.9 %                  2.8 %                  4.3 %

International Developed Equity ETFs (in
Beginning of period assets                  $         2,846        $   2,964        $         2,867        $         2,407        $         2,311
Inflows/(outflows)                                      (58 )            137                     57                    381                    565
Market appreciation/(depreciation)                      108             (255 )                 (423 )                  108                   (375 )

End of period assets                        $         2,896        $   2,846        $         2,501        $         2,896        $         2,501

Average assets during the period            $         2,859        $   2,853        $         2,722        $         2,798        $         2,680

Emerging Markets Equity ETFs (in
Beginning of period assets                  $         5,430        $   5,594        $         3,988        $         3,613        $         3,780
Inflows/(outflows)                                      736              462                    102                  2,596                    506
Market appreciation/(depreciation)                      376             (626 )                 (860 )                  333                 (1,056 )

End of period assets                        $         6,542        $   5,430        $         3,230        $         6,542        $         3,230

Average assets during the period            $         5,915        $   5,398        $         3,719        $         5,365        $         3,733

U.S. Equity ETFs (in millions)
Beginning of period assets                  $         4,094        $   4,275        $         2,612        $         3,429        $         2,057
Inflows/(outflows)                                      363             (113 )                  241                    815                    668
Market appreciation/(depreciation)                      183              (68 )                 (330 )                  396                   (202 )

End of period assets                        $         4,640        $   4,094        $         2,523        $         4,640        $         2,523

Average assets during the period            $         4,393        $   4,101        $         2,528        $         4,161        $         2,352

Currency ETFs (in millions)
Beginning of period assets                  $           769        $     881        $         1,896        $           950        $         1,179
Inflows/(outflows)                                     (129 )            (82 )                 (566 )                 (315 )                   87
Market appreciation/(depreciation)                       14              (30 )                 (136 )                   19                    (72 )

End of period assets                        $           654        $     769        $         1,194        $           654        $         1,194

Average assets during the period            $           694        $     828        $         1,786        $           819        $         1,599

International Fixed Income ETFs (in
Beginning of period assets                  $         1,698        $   1,735        $         1,379        $         1,506        $           564
Inflows/(outflows)                                      148               (8 )                  280                    301                  1,057
Market appreciation/(depreciation)                       58              (29 )                 (166 )                   97                   (128 )

End of period assets                        $         1,904        $   1,698        $         1,493        $         1,904        $         1,493

Average assets during the period            $         1,749        $   1,716        $         1,780        $         1,697        $         1,218

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                                                                    Three Months Ended                                         Nine Months Ended
                                                 September 30,           June 30,           September 30,           September 30,             September 30,
                                                     2012                  2012                 2011                     2012                     2011
Alternative Strategy ETFs (in millions)
Beginning of period assets                      $           167         $      242         $           192         $            277          $             0
Inflows/(outflows)                                          (24 )              (58 )                    65                     (105 )                    259
Market appreciation/(depreciation)                            4                (17 )                   (14 )                    (25 )                    (16 )

End of period assets                            $           147         $      167         $           243         $            147          $           243

Average assets during the period                $           159         $      220         $           227         $            211          $           124

Average ETF assets during the period
Emerging markets equity ETFs                                 38 %               36 %                    29 %                     36 %                     32 %
U.S. equity ETFs                                             28 %               27 %                    20 %                     28 %                     20 %
International developed equity ETFs                          18 %               19 %                    22 %                     19 %                     23 %
International fixed income ETFs                              11 %               11 %                    14 %                     11 %                     10 %
Currency ETFs                                                 4 %                6 %                    14 %                      5 %                     14 %
Alternative strategy ETFs                                     1 %                1 %                     1 %                      1 %                      1 %

Total                                                       100 %              100 %                   100 %                    100 %                    100 %

Average ETF advisory fee during the period                 0.54 %             0.54 %                  0.55 %                   0.54 %                   0.55 %

Number of ETFs-end of the period

International developed equity ETFs                          18                 18                      18                       18                       18
U.S. equity ETFs                                             12                 12                      12                       12                       12
Currency ETFs                                                 7                  7                       9                        7                        9
International fixed income ETFs                               5                  5                       2                        5                        2
Emerging markets equity ETFs                                  5                  4                       4                        5                        4
Alternative strategy ETFs                                     2                  2                       2                        2                        2

Total                                                        49                 48                      47                       49                       47

Headcount                                                    70                 66                      64                       70                       64

Note: Previously issued statistics may be restated due to trade adjustments

Source: Investment Company Institute, Bloomberg, WisdomTree

Three Months Ended September 30, 2012 Compared to September 30, 2011


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