Artisan Partners Asset Management Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; unaudited. Artisan is an active investment manager operating through Artisan Partners Holdings. APAM owned approximately 69% of Holdings at quarter-end and reports a significant noncontrolling interest.
Financial results and liquidity
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Revenue | $212.0 million | $184.1 million |
| Operating income / margin | $80.0 million / 37.7% | $58.0 million / 31.5% |
| Net income attributable to APAM | $41.3 million | $19.8 million |
| GAAP diluted EPS | $0.75 | $0.37 |
| Adjusted net income / adjusted EPS | $59.3 million / $0.78 | $38.8 million / $0.52 |
| Operating cash flow | $167.3 million | $119.0 million |
- Revenue rose 15%, primarily reflecting average AUM growth of 17% to $118.3 billion; the weighted average fee declined to 72.8 basis points from 73.7 basis points, mainly due to asset mix.
- Operating expenses increased 5% to $132.0 million. Compensation and benefits rose 6% to $105.2 million, including higher incentive compensation and restricted-stock expense; the prior-year period included $6.3 million of pre-offering share-based compensation that did not recur.
- Reported non-operating income was $4.0 million, versus a $2.7 million loss. Q1 2018 included $6.3 million of gains from consolidated investment products and $0.3 million of investment gains on unconsolidated products. These gains are excluded in management’s adjusted measures.
- Effective tax rate fell to 14.6% from 23.1%, primarily following the U.S. federal corporate tax-rate reduction to 21%. Management’s estimated adjusted effective tax rate was 23.5%, versus 37.0%.
- Cash and cash equivalents were $200.8 million at March 31, compared with $137.3 million at year-end; the balance sheet also reports $44.8 million of cash held by consolidated investment products, which is not available for general corporate purposes. The company had $100 million available under its undrawn revolving facility.
- Debt was approximately $200 million, comprising senior notes of $50 million due 2019, $90 million due 2022 and $60 million due 2025. The company reported covenant compliance. Interest expense was $2.8 million.
- Operating cash flow increased $48.3 million year over year; management cited working-capital timing, including executive bonus payments, as well as increased revenue and operating income. Financing cash outflow was $80.0 million, including $70.2 million of dividends and $22.7 million of partnership distributions.
Material changes and business developments
- Quarter-end AUM was $114.8 billion, down $0.7 billion (0.6%) from December 31, 2017. Net client outflows of $0.6 billion and market depreciation of $0.1 billion drove the quarterly decline.
- Compared with March 31, 2017, AUM increased $11.1 billion (10.7%), primarily from $16.8 billion of market appreciation, partly offset by $5.7 billion of net outflows. Average AUM rose to $118.3 billion from $101.1 billion.
- Outflows were concentrated in U.S. Mid-Cap Growth ($1.1 billion) and Non-U.S. Growth ($0.7 billion). Management anticipated those trends would continue further into 2018. Several strategies were closed or restricted to most new investors.
- APAM completed a February follow-on offering and unit purchases/exchanges that increased its Holdings ownership from 67% to 69%. Class B shares’ voting rights changed from five votes per share to one in February.
- Dividends declared per Class A share were $1.39 in Q1, comprising a $0.60 quarterly dividend and a $0.79 special dividend. The board declared another $0.60 quarterly dividend for May 2018 and said it expected quarterly dividends during 2018, subject to board approval. Management said the board might consider a variable quarterly dividend.
Outlook, risks and unusual items
- Management described results as likely to be “lumpy,” with shorter-term performance influenced by markets and AUM flows. Long-term results depend on investment performance, maintaining existing strategies and developing strategies that meet client needs.
- Management said the company may pay a year-end special dividend based on annual adjusted earnings, business conditions and desired cash retention; dividends are not assured. The dividend policy could change during 2018.
- Tax receivable agreement (TRA) liability was $400.5 million at March 31, up from $385.4 million at year-end. Artisan expected approximately $36 million of TRA payments in 2018 and paid $27.3 million on April 17. TRA payments generally provide counterparties 85% of specified tax savings; actual timing and amounts depend on taxable income, tax rates, unit exchanges and other factors. In certain circumstances, payments may be accelerated or exceed realized tax benefits.
- Other principal risks identified include adverse markets or economic conditions, weak investment performance, loss of key investment professionals or senior management, regulatory change, and operational or technical errors. Management reported no legal or administrative proceedings expected to have a material effect and no material off-balance-sheet arrangements.
- New revenue-recognition guidance adopted in 2018 had no material effect on operating or net income. The company was evaluating the 2019 lease standard, which it expected to significantly increase assets and liabilities but not materially affect operating results.
Investor verification priorities
- Track net flows by strategy and vehicle, especially continued outflows in U.S. Mid-Cap Growth and Non-U.S. Growth, and the effects of strategy closures.
- Separate underlying operating performance from consolidated investment-product gains and noncontrolling interests when assessing GAAP and adjusted earnings.
- Monitor fee-rate and asset-mix changes, compensation costs, and the conversion of AUM growth into operating margin and cash flow.
- Assess dividend capacity alongside TRA payments, debt maturities and the board’s potential dividend-policy changes.
- Review the assumptions behind the $400.5 million TRA liability and future tax benefits, including potential accelerated-payment scenarios.