Artisan Partners Asset Management Inc. quarterly report, Q1 FY2016

Business context and reporting period

Artisan Partners Asset Management Inc. (APAM) is an active investment manager operating through Artisan Partners Holdings LP. This unaudited Form 10-Q covers the three months ended March 31, 2016, compared with the three months ended March 31, 2015, and the balance sheet compares March 31, 2016 with December 31, 2015. APAM owned approximately 55% of Holdings at quarter-end; the remaining earnings are reported as noncontrolling interests.

Financial results and key metrics

Net cash provided by operations exceeded net income; investing activities used $0.7 million and financing activities used $59.3 million. Cash increased by $51.7 million during the quarter. The $100 million revolving credit facility was undrawn, and APAM reported compliance with debt covenants. Face-value debt was about $200 million, with $217.9 million of cash at quarter-end.

Material changes versus the prior comparable period

• Revenue declined 14%, mainly because average AUM fell 14.3% to $92.9 billion. The weighted average fee remained 76 basis points.
• Quarter-end AUM fell 2.8% from year-end, reflecting $1.5 billion of market depreciation and $1.3 billion of net client outflows.
• Operating expenses decreased 12% to $119.8 million, principally from lower incentive compensation and distribution costs and prior-year Developing World launch costs. Compensation and benefits were $95.3 million, including $18.9 million of share-based compensation.
• APAM’s effective tax rate rose to 22.2% from 8.7%. The 2015 quarter included $7.7 million of discrete deferred-tax benefits; about 47% of Holdings’ Q1 2016 earnings were attributable to partners not taxed at the corporate level.
• Operating cash flow declined to $111.7 million from $128.7 million. Financing cash use was lower than in 2015, when equity issuance proceeds and a matching equity purchase materially affected cash flows.

Management commentary, outlook, risks and unusual items

• Management attributed outflows primarily to the U.S. Value team, which had $1.2 billion of net outflows. APAM announced that the team would cease managing the U.S. Small-Cap Value strategy in Q2 2016; the associated fund was expected to merge into Artisan Mid Cap Value Fund in late May.
• High Income, Developing World and Global Value strategies had net inflows of $334 million, $170 million and $88 million, respectively. Non-U.S. Growth had $631 million of net outflows; it was partially closed to new investors and further closures were planned for October 2016. Management said U.S. Value outflows could continue if underperformance and client trends persist.
• Management stated it expected to pay a quarterly dividend during 2016, subject to board approval. The board declared a $0.60-per-share quarterly dividend payable May 31, 2016, and expected to consider a special dividend after year-end based on earnings, business conditions and desired cash reserves. These expectations are not assurances.
• The tax receivable agreement (TRA) liability was $601.3 million, up from $589.1 million at year-end, and is estimated to represent 85% of specified tax benefits. APAM expected approximately $28 million of TRA payments in 2016; about $21 million was paid April 15. Payments can vary and, in some circumstances, may be accelerated or exceed realized tax benefits.
• Debt comprises senior notes with $60 million due in 2017, $50 million in 2019 and $90 million in 2022, at fixed annual rates of 4.98%, 5.32% and 5.82%, respectively. The filing reported no material off-balance-sheet arrangements or legal proceedings believed to have a material effect. The IRS was examining APAM’s 2014 tax year.
• Key stated risks include adverse markets, investment underperformance, client outflows, loss of key investment professionals, regulatory change, and operational or technical errors. Management reported effective disclosure controls and no material change in internal control during the quarter.

Most important facts for investors to verify

1. Whether AUM, net flows and investment performance stabilize, particularly for U.S. Value and Non-U.S. Growth strategies, and the effects of announced strategy closures.
2. Whether distributions and dividends remain supportable given operating cash generation, planned distributions and future TRA payments.
3. The timing and ultimate amount of TRA payments, including sensitivity to taxable income, tax law, ownership exchanges and potential acceleration provisions.
4. Whether margins and earnings recover as average AUM changes, while monitoring rising technology costs and share-based compensation.
5. The outcome of the IRS examination of the 2014 tax year and any implications for tax assets, the TRA liability or cash needs.