Artisan Partners Asset Management Inc. quarterly report, Q3 FY2021

Business context and reporting period

Artisan Partners Asset Management Inc. (APAM) is an active investment manager. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2021; comparisons are with the corresponding 2020 periods unless noted. APAM owned approximately 83% of Artisan Partners Holdings at quarter-end, so reported results include noncontrolling interests.

Financial and operating highlights

Management fees drove revenue growth: Q3 rose 36%, mainly reflecting average AUM growth of 36% to $177.6bn; nine-month revenue rose 43%, with average AUM up 44% to $170.4bn. Performance fees were $0.4m in Q3 and $11.2m for nine months, broadly flat year over year for the nine-month period. Weighted average management fees were 70.7 basis points in Q3 and 70.8 basis points for nine months.

At September 30, AUM was $173.6bn, up 29% from $134.3bn a year earlier but down $1.6bn from June 30, 2021, due to negative investment returns. Q3 net client cash flows were $11m; nine-month flows were $2.5bn, down from $5.1bn in 2020. Twelve of 20 strategies had Q3 inflows totaling $2.4bn, offset by $2.4bn of outflows elsewhere.

Q3 compensation and benefits were $142.2m, up 31%, primarily due to revenue-linked incentive pay, higher headcount and long-term awards. Nine-month operating margin improved to 44.1% from 38.3% as revenue growth outpaced expense growth. Adjusted operating margin, a non-GAAP measure, was 45.2% for Q3 and 44.2% for nine months. Adjusted EPS was $1.33 in Q3 and $3.74 for nine months, versus GAAP EPS of $1.30 and $3.84, respectively.

Cash, debt and capital allocation

Cash and cash equivalents were $273.3m at September 30, 2021, compared with $155.0m at December 31, 2020; this excludes $16.6m held by consolidated investment products. The company reported $404.2m of operating cash flow for the nine months. Cash, cash equivalents and restricted cash, including consolidated investment products, totaled $290.5m. Investing activities used $26.1m and financing activities used $252.2m in the nine-month period, including $203.5m in dividends and $31.3m in tax receivable agreement payments.

Borrowings had a $200m stated principal balance ($199.4m carrying value): $90m of notes mature in August 2022, $60m in 2025 and $50m in 2027. The $100m revolving facility, due August 2022, was undrawn. APAM reported compliance with debt covenants. Operating lease liabilities were $85.4m. The tax receivable agreement liability was $404.4m; management expected approximately $33m of related payments in 2022 and no further payments in 2021.

APAM paid a $1.00-per-share Class A quarterly dividend in Q3. After quarter-end, the board declared a $1.07-per-share dividend, payable November 30, 2021. Management said its variable quarterly dividend is expected, subject to board approval, to be approximately 80% of quarterly cash generation; the board would consider a special dividend after year-end.

Outlook, risks and unusual items

• Management expects Artisan Funds’ November 2021 annual distributions to produce approximately $2bn of net client outflows from investors who do not reinvest, potentially increasing mutual fund redemptions.
• The firm plans to launch initial strategies for a new emerging-markets debt investment team in the first half of 2022.
• Three funds/strategies were closed or limited to most new investors, and the company was actively managing capacity in Global Opportunities and U.S. Small-Cap Growth. Capacity decisions may constrain near-term AUM growth.
• COVID-19 continued to affect work arrangements and travel. Management anticipated most associates would return to offices more often than not by year-end and expected operating costs to move toward pre-pandemic levels as office work and travel resumed. It cited potential for client redemptions, operational errors, delays and communication challenges amid continued uncertainty.
• Key business sensitivities include market performance, investment results, client flows, fee mix, retaining investment professionals and competition. Management emphasized that results may be “lumpy.”
• Non-operating results included investment gains and losses, including gains/losses associated with consolidated investment products and investments that economically hedge cash incentive awards. A private fund was deconsolidated after the company’s seed investment redemption; the filing reported no net income statement impact.
• TRA payments can, in certain circumstances, accelerate or exceed realized tax benefits; management said cash on hand would be used, with borrowing potentially needed depending on amount and timing. No material legal proceedings were identified. Management reported effective disclosure controls and no material change in internal control.

Important facts for investors to verify

• Whether AUM and client flows sustain fee revenue, particularly following the anticipated November fund distributions and weak Q3 investment returns.
• Whether the $1.07 dividend and stated payout approach remain supported by cash generation and board approval.
• The timing and funding of the $90m 2022 debt maturity, revolving facility renewal or repayment, and future TRA payments.
• How compensation, new-team investment and returning office/travel costs affect margins as revenue and AUM change.
• Performance and capacity developments across strategies, and the effect of APAM’s ownership and noncontrolling interests on per-share economics.