Westwood Holdings Group Inc: Form 10-Q for the period ended Sep 30, 2024

Forward-Looking Statements

Statements in this report and our 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,” “potentially,” “may,” “designed” 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, 2023 and those risks set forth below:

• the composition and market value of our AUM and AUA;
• our ability to maintain our fee structure in light of competitive fee pressures;
• risks associated with actions of activist stockholders;
• distributions to our common stockholders have included and may in the future include a return of capital;
• inclusion of foreign company investments in our AUM;
• regulations adversely affecting the financial services industry;
• our ability to maintain effective cyber security;
• litigation risks;
• our ability to develop and market new investment strategies successfully;
• our reputation and our relationships with current and potential customers;
• our ability to attract and retain qualified personnel;
• our ability to perform operational tasks;
• our ability to select and oversee third-party vendors;
• our dependence on the operations and funds of our subsidiaries;
• our ability to maintain effective information systems;
• our ability to prevent misuse of assets and information in the possession of our employees and third-party vendors, which could damage our reputation and result in costly litigation and liability for our clients and us;
• our stock is thinly traded and may be subject to volatility;
• competition in the investment management industry;
• our ability to avoid termination of client agreements and the related investment redemptions;
• the significant concentration of our revenues in a small number of customers;
• we have made and may continue to make business combinations as a part of our business strategy, which may present certain risks and uncertainties;
• our relationships with investment consulting firms;
• our ability to identify and execute on our strategic initiatives;
• our ability to declare and pay dividends;
• our ability to fund future capital requirements on favorable terms;
• our ability to properly address conflicts of interest;
• our ability to maintain adequate insurance coverage; and
• our ability to maintain an effective system of internal controls.

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 Corp., Westwood Advisors, L.L.C. and Salient Advisors, LP (each of which is an SEC-registered investment advisor and referred to hereinafter together as “Westwood Management”) and Westwood Trust. Westwood Management provides investment advisory services to institutional investors, a family of mutual funds called 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 to institutions and high net worth individuals. Our revenues are generally derived from fees based on a percentage of AUM.

Our revenues are generally derived from fees based on a percentage of AUM and AUA, and Westwood Management and Westwood Trust collectively had AUM of approximately $16.8 billion and AUA of approximately $1.0 billion at September 30, 2024. We have established a track record of delivering competitive, risk-adjusted returns for our clients.

With respect to most of our AUM, we utilize a “value” investment style focused on achieving superior long-term, risk-adjusted returns by investing in companies with high levels of free cash flow, improving returns on equity and strengthening balance sheets that are well positioned for growth but whose value is not fully recognized in the marketplace. This investment approach is designed to limit downside during unfavorable periods and provide superior real returns over the long term. Our investment teams have significant industry experience. Our investment team members have an average investment experience of over twenty years.

We have built a foundation in terms of personnel and infrastructure to support a much larger business and we have developed investment strategies that we believe will be sought after within our target institutional, wealth management and intermediary markets. Developing new products and growing the organization has resulted in our incurring expenses that, in some cases, have not yet generated significant offsetting revenues. We believe that investors will recognize the potential for new revenue streams inherent in these products and services; however, there is no guarantee that they will occur.

Revenues

We derive our revenues from investment advisory fees, trust fees and other revenues. Our advisory fees are generated by Westwood Management, which manages client accounts under investment advisory and sub-advisory agreements. Advisory fees are typically calculated based on a percentage of AUM and AUA and are paid in accordance with the terms of the agreements. Advisory fees are paid quarterly in advance based on AUM on the last day of the preceding quarter, quarterly in arrears based on AUM on the last day of the quarter just ended or are based on a daily or monthly analysis of AUM for the stated period. We recognize advisory fee revenues as services are rendered. Certain of our clients have a contractual performance-based fee component in their contracts, which generates additional revenues if we outperform a specified index over a specific period of time. We record revenue for performance-based fees at the end of the measurement period. Since our advance paying clients’ billing periods coincide with the calendar quarter to which such payments relate, revenue is 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 AUM. Westwood Trust also provides trust services to a small number of clients on a fixed fee basis. Trust fees are primarily calculated quarterly in arrears based on a daily average of AUM for the quarter. Since billing periods for most of Westwood Trust's clients coincide with the calendar quarter, revenue is fully recognized within the quarter, and our Consolidated Financial Statements contain no deferred advisory fee revenues.

Our other revenues primarily consist of investment income from seed money investments into new investment strategies.

Employee Compensation and Benefits

Employee compensation and benefits costs generally consist of salaries, sales commissions, incentive compensation, stock-based compensation expense and benefits.

Sales and Marketing

Sales and marketing costs relate to our marketing efforts, including travel and entertainment, direct marketing and advertising costs.

Westwood Mutual Funds

Expenses for Westwood mutual funds relate to our marketing, distribution and administration of the Westwood Funds®.

Information Technology

Information technology expenses include costs associated with proprietary investment research tools, maintenance and support, computing hardware, software licenses, telecommunications and other related costs.

Professional Services

Professional services expenses generally consist of costs associated with sub-advisory fees, audit, legal and other professional services.

General and Administrative

General and administrative expenses generally consist of costs associated with the lease of office space, amortization, depreciation, insurance, custody expense, Directors' fees, investor relations, licenses and fees, office supplies and other miscellaneous expenses.

(Gain) loss from change in fair value of contingent consideration

(Gain) loss from change in fair value of contingent consideration consists of fair value adjustments related to contingent consideration from our 2022 acquisition of Salient, with gains representing reductions in value and losses representing increases in value.

Acquisition expenses

Acquisition expenses consist of costs related to the Salient Acquisition.

Net Change in Unrealized Appreciation (Depreciation) on Private Investments

Net change in unrealized appreciation (depreciation) on private investments includes changes in the value of our private equity investments.

Net Investment Income

Net investment income primarily includes interest and dividend income on fixed income securities and money market funds.

Other Income

Other income primarily consists of income from the sublease of a portion of our corporate offices and the receipt of life insurance proceeds.

Firm-wide Assets Under Management

Firm-wide assets under management of $17.7 billion at September 30, 2024 consisted of $16.8 billion of AUM and $1.0 billion of AUA.

AUM increased $2.4 billion to $16.8 billion at September 30, 2024 compared with $14.4 billion at September 30, 2023. The average of beginning and ending AUM for the third quarter of 2024 was $16.3 billion compared to $14.7 billion for the third quarter of 2023.

The following table displays AUM as of September 30, 2024 and 2023 (in millions):

(1) Institutional includes (i) separate accounts of corporate pension and profit sharing plans, public employee retirement funds, Taft-Hartley plans, endowments, foundations and individuals; (ii) sub-advisory relationships where Westwood provides investment management services for funds offered by other financial institutions; (iii) pooled investment vehicles, including collective investment trusts; and (iv) managed account relationships with brokerage firms and other RIAs that offer Westwood products to their customers.

(2) Wealth Management 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 and assets for which Westwood Advisors, L.L.C. provides advisory services to high net worth individuals. Investment sub-advisory services are provided for the common trust funds by Westwood Management and unaffiliated sub-advisors. For certain assets in this category Westwood Trust provides limited custodial services for a minimal or no fee, viewing these assets as potentially converting to fee-generating managed assets in the future.

(3) Mutual Funds include the Westwood Funds®, a family of mutual funds for which Westwood Management serves as advisor. These funds are available to individual investors, institutional investors and wealth management accounts.

(4) AUM excludes $1.0 billion and $1.1 billion of AUA as of September 30, 2024 and 2023, respectively, related to our model portfolios for which we provide investment advice on a fee basis without having investment management authority.

Roll-Forward of Assets Under Management

(in millions)

* Certain assets under management acquired from Salient were reclassified from Mutual Funds to Institutional as of December 31, 2022 to be consistent with the classification of existing assets.

Three months ended September 30, 2024 compared to the three months ended September 30, 2023

The change in AUM for the three months ended September 30, 2024 was due to market appreciation of $1.1 billion offset by net outflows of $0.1 billion.

The change in AUM for the three months ended September 30, 2023 was due to market depreciation of $0.3 billion and net outflows of $0.3 billion. Net outflows were primarily related to our SmallCap strategy.

Nine months ended September 30, 2024 compared to the nine months ended September 30, 2023

The $1.3 billion increase in AUM for the nine months ended September 30, 2024 was due to market appreciation of $1.9 billion offset by net outflows of $0.6 billion. Net outflows were primarily related to our LargeCap Value strategy.

The $0.4 billion decrease in AUM for the nine months ended September 30, 2023 was due to net outflows of $0.9 billion offset by market appreciation of $0.5 billion. Net outflows were primarily related to our Income Opportunity and MLP strategies.

Roll-Forward of Assets Under Advisement

(in millions)

Results of Operations

The following table (dollars in thousands) and discussion of our results of operations are based upon data derived from the Condensed Consolidated Statements of Comprehensive Income contained in our Condensed Consolidated Financial Statements and should be read in conjunction with those statements included elsewhere in this report.

NM Not meaningful

Three months ended September 30, 2024 compared to three months ended September 30, 2023

Total revenues. Total revenues for the three months ended September 30, 2024 were higher than revenues for the three months ended September 30, 2023 due to higher average AUM.

Employee compensation and benefits. Employee compensation and benefits for the three months ended September 30, 2024 increased $0.9 million compared to the three months ended September 30, 2023 primarily due to higher incentive compensation following increased AUM balances and additional headcount.

Professional services. Professional services for the three months ended September 30, 2024 increased $0.8 million compared to the three months ended September 30, 2023 primarily due to higher consulting costs related to our Managed Investment Solutions ("MIS") capability.

(Gain) loss from change in fair value of contingent consideration. We recorded a loss of $1.8 million upon the

remeasurement of contingent consideration of the Salient Acquisition primarily due to positive changes in growth projections following asset appreciation in the quarter.

Other income. Other income decreased due to the receipt of life insurance proceeds of $5.0 million in the third quarter of 2023.

Income tax provision. Our effective tax rate differed from the 21% statutory rate for the third quarter of 2024 primarily due to permanent differences between book and tax restricted stock expense based on a decrease in our stock price between the restricted stock grant and vesting dates and the discrete impact of life insurance proceeds received in 2023.

Nine months ended September 30, 2024 compared to nine months ended September 30, 2023

Total revenues. Total revenues for the nine months ended September 30, 2024 were higher than revenues for the nine months ended September 30, 2023 due to higher average AUM.

Employee compensation and benefits. Employee compensation and benefits for the nine months ended September 30, 2024 increased $1.4 million compared to the nine months ended September 30, 2023 primarily due to higher incentive compensation following increased AUM balances and additional headcount.

Professional services. Professional services nine months ended September 30, 2024 increased $0.8 million the nine months ended September 30, 2023 primarily due to higher consulting costs related to our MIS capability.

(Gain) loss from change in fair value of contingent consideration. We recorded a loss of $3.7 million upon the

remeasurement of contingent consideration of the Salient Acquisition primarily due to positive changes in growth projections following asset appreciation in the period and revised asset flow expectations.

Other income. Other income decreased due to the receipt of life insurance proceeds of $5.0 million in the third quarter of 2023.

Net investment income. Net investment income increased primarily due to additional interest income in the period.

Income tax provision. Our effective tax rate for the nine months ended September 30, 2024 differed from the 21% statutory rate for 2024 primarily due to permanent differences between book and tax restricted stock expense based on a decrease in our stock price between the restricted stock grant and vesting dates and the discrete impact of life insurance proceeds received in 2023.

Supplemental Financial Information

As supplemental information, we are providing non-GAAP performance measures that we refer to as Economic Earnings and Economic EPS. We provide these measures in addition to, not as a substitute for, comprehensive income attributable to Westwood Holdings Group, Inc. and earnings per share, which are reported on a GAAP basis. Our management and Board of Directors review Economic Earnings and Economic EPS to evaluate our ongoing performance, allocate resources, and review our dividend policy. We believe that these non-GAAP performance measures, while not substitutes for GAAP comprehensive income attributable to Westwood Holdings Group, Inc. or earnings per share, 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 also considering financial information prepared in accordance with GAAP.

We define Economic Earnings as comprehensive income attributable to Westwood Holdings Group, Inc. plus non-cash equity-based compensation expense, amortization of intangible assets and deferred taxes related to goodwill. Although depreciation on fixed assets is a non-cash expense, we do not add it back when calculating Economic Earnings because depreciation charges represent an allocation of the decline in the value of the related assets that will ultimately require replacement. Although gains and losses from changes in the fair value of contingent consideration are non-cash, we do not add or subtract those back when calculating Economic Earnings because gains and losses on changes in the fair value of contingent consideration are considered regular following an acquisition. In addition, we do not adjust Economic Earnings for tax deductions related to restricted stock expense or amortization of intangible assets. Economic EPS represents Economic Earnings divided by diluted weighted average shares outstanding.

The following tables (in thousands, except share and per share amounts) provide a reconciliation of comprehensive income attributable to Westwood Holdings Group, Inc. to Economic Earnings and Economic Earnings by segment. We have included the tax impact of adjustments for all periods presented.

Liquidity and Capital Resources

Historically we have funded our operations and cash requirements with cash generated from operating activities. We may also use cash from operations to pay dividends to our stockholders or for deferred contingent consideration payments. We had no debt as of September 30, 2024 and December 31, 2023. The changes in net cash provided by operating activities generally reflect changes in earnings plus the effects of non-cash items and changes in working capital, including liquidation of investments used to cover current liabilities. 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.

We had cash and short-term investments of $48.3 million and $53.1 million as of September 30, 2024 and December 31, 2023, respectively. At September 30, 2024 and December 31, 2023, working capital aggregated $52.5 million and $53.6 million, respectively.

During the nine months ended September 30, 2024, cash flow provided by operating activities was $12.2 million, which included net sales of current investments of $6.3 million and a reduction in compensation and benefits payable of $1.3 million. During the nine months ended September 30, 2023, cash flow used in operating activities was $5.7 million, which included net purchases of current investments of $15.6 million and a reduction in compensation and benefits payable of $1.4 million.

Cash flow used in investing activities during the nine months ended September 30, 2024 was related to the purchase of investments. Cash flow provided by investing activities during the nine months ended September 30, 2023 was primarily due to the receipt of life insurance proceeds, offset by cash for the Broadmark Acquisition.

Cash flows used in financing activities of $8.3 million for the nine months ended September 30, 2024 reflected the payment of dividends, deferred contingent consideration payments, purchases of treasury stock and restricted stock returned for the payment of taxes. Cash flows used in financing activities of $5.1 million for the nine months ended September 30, 2023 reflected the payment of dividends and restricted stock returned for the payment of taxes.

Westwood Trust is required to maintain cash and investments in an amount equal to the minimum restricted capital of $4.0 million, as required by the Texas Finance Code. Restricted capital is included in Investments in the accompanying Condensed Consolidated Balance Sheets. At September 30, 2024, Westwood Trust had approximately $12.3 million in excess of its minimum capital requirement.

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, 2023. We believe that current cash and short-term investment balances plus cash generated from operations will be sufficient to meet both 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. 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.

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, 2023. Information with respect to our critical accounting policies and estimates that we believe could have the most significant effect on our reported consolidated results and require difficult, subjective or complex judgment by management is described under “Critical Accounting Policies and Estimates” in Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2023.

Accounting Developments

Refer to Note 2 “Summary of Significant Accounting Policies” in our Condensed Consolidated Financial Statements included in Part I, Item 1. “Financial Statements” of this Quarterly Report on Form 10-Q for a description of recently issued accounting guidance.

There have been no significant changes in our Quantitative and Qualitative Disclosures about Market Risk from those previously reported in our Annual Report on Form 10-K for the year ended December 31, 2023.

Evaluation of Disclosure Controls and Procedures

Our disclosure controls and procedures are designed to ensure that information required to be disclosed in the reports we file or submit under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), (1) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (2) is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, to allow timely decisions regarding required disclosure. An evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on this evaluation, our management, including our Chief Executive Officer and our Chief Financial Officer, concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective to ensure that information required to be disclosed in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and is accumulated and communicated to management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

Changes in Internal Controls over Financial Reporting

During the quarter ended September 30, 2024, there were no changes in our internal controls over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Our business and future results may be affected by a number of risks and uncertainties that should be considered carefully. In addition, this report also contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in such forward-looking statements as a result of certain factors, including the risks described in Part I, Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2023 and the risks set forth below.

There have been no material changes to the risk factors previously disclosed in the Form 10-K. You should carefully consider the following risks and the risks included in the Company’s Annual Report on Form 10-K, together with all of the other information in this Quarterly Report on Form 10-Q, including our unaudited condensed consolidated financial statements and the related notes included elsewhere in this Quarterly Report on Form 10-Q. The occurrence of any single risk or any combination of risks could materially and adversely affect our business, financial condition, results of operations, cash flows and the trading price of our common stock.