Artisan Partners Asset Management Inc. — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016. Financial statements are unaudited. Artisan is an active investment manager whose revenue is generated primarily from fees based on assets under management (AUM).
Key financial and operating metrics
| Metric | Q3 2016 | Q3 2015 | First nine months 2016 | First nine months 2015 |
|---|---|---|---|---|
| Revenue | $184.1 million | $198.3 million | $539.4 million | $613.5 million |
| Operating income | $61.9 million | $70.6 million | $175.6 million | $216.7 million |
| Operating margin | 33.6% | 35.6% | 32.6% | 35.3% |
| Net income attributable to APAM | $19.1 million | $18.5 million | $53.7 million | $61.7 million |
| GAAP diluted EPS | $0.41 | $0.44 | $1.15 | $1.38 |
| Adjusted operating margin (non-GAAP) | 37.3% | 40.9% | 36.6% | 40.5% |
| Adjusted net income per adjusted share (non-GAAP) | $0.56 | $0.67 | $1.60 | $2.06 |
- At September 30, AUM was $99.8 billion, up 2.9% year over year. Q3 market appreciation of $5.8 billion more than offset $935 million in net outflows. Average AUM was down 6.2% year over year in Q3 and 11.3% over the first nine months.
- Weighted average fee rates were 74 basis points in Q3 and 75 basis points for the nine months, versus 75 and 76 basis points, respectively, in 2015.
- Operating cash flow was $258.3 million for the first nine months, compared with $298.6 million in 2015. Investing activities used $4.6 million and financing activities used $207.3 million; cash increased to $212.6 million from $166.2 million at year-end 2015.
- At September 30, borrowings were $200 million gross, principally fixed-rate senior notes; the $100 million revolving facility was undrawn. Debt maturities include $60 million in 2017, $50 million in 2019 and $90 million in 2022. The company reported compliance with debt covenants.
- Current assets included $212.6 million cash and $67.1 million accounts receivable. Total liabilities were $887.0 million, including a $592.0 million tax receivable agreement (TRA) liability; deferred tax assets were $684.6 million.
Material changes versus comparable periods
- Nine-month revenue declined 12%, primarily because average AUM fell 11%; Q3 revenue declined 7%, with lower average AUM the main driver. Lower AUM and market volatility were partly offset by positive market appreciation during 2016.
- Nine-month operating income fell 19% and APAM-attributable net income fell 13%. Lower incentive compensation, distribution costs and prior-year Developing World start-up costs reduced expenses, but did not offset the revenue decline. Communication and technology expense increased.
- Q3 APAM-attributable net income increased about 3% year over year, while EPS declined from $0.44 to $0.41, reflecting higher weighted-average share count and changes in income allocation. Q3 non-operating results also improved versus 2015, including a $0.7 million TRA estimate gain versus a $5.8 million loss.
- Net outflows for the first nine months rose to $4.6 billion from $3.8 billion in 2015. U.S. Value had $3.5 billion of outflows and Non-U.S. Growth $2.3 billion; the latter was closed to most new retail and intermediary investors. Global Value, Credit and Developing World had inflows.
- APAM’s ownership of Artisan Partners Holdings increased from 54% to approximately 57%, partly through 1.6 million unit exchanges. These exchanges increased deferred tax assets and TRA obligations.
Outlook, management commentary and risks
- Management said eight of 11 strategies with five-year records and seven of eight strategies with ten-year records outperformed their applicable benchmarks at quarter-end. Global Opportunities and Global Equity were identified as open to new clients with realizable capacity; management said continued relative performance and demand could support asset growth.
- Management expected approximately $3–4 million of Q4 operating expenses related to establishing the new Artisan Thematic team and other hires. Chris Smith was announced as founding portfolio manager; U.S. Value portfolio manager Scott Satterwhite retired in October 2016.
- Management estimated November 2016 Artisan Funds distributions could produce about $250 million of net outflows if investors do not reinvest, compared with about $616 million in November 2015.
- The board declared a $0.60 quarterly dividend per Class A share payable November 30, 2016, and a $35.9 million Holdings distribution. Management expected to consider a special dividend after year-end, subject to business conditions and board approval; future dividends are not assured.
- Management expected approximately $28 million of TRA payments in 2016: about $21 million was paid in April and $7 million in October. TRA payments and the large recorded liability depend on taxable income, tax law, ownership exchanges and other assumptions; accelerated payments could exceed realized tax benefits and could require cash on hand or borrowing.
- Key business risks include market declines, investment underperformance, client outflows, fee pressure, loss of key investment professionals, and regulatory or operational issues. Management reported no material legal or administrative proceedings, no off-balance-sheet arrangements, and effective disclosure controls.
Important facts for investors to verify
- Whether net outflows persist in U.S. Value, Non-U.S. Growth and other closed or underperforming strategies, and whether inflows in growth strategies continue.
- How average AUM, strategy and vehicle mix, and fee rates affect revenue and margins in subsequent quarters.
- The assumptions, timing and cash funding needs underlying the $592.0 million TRA liability and expected payments.
- Whether share-based compensation, new-team expenses and technology investment affect future margins, and whether dividends—including any special dividend—are maintained.
- Reported non-GAAP adjusted measures alongside GAAP results; adjusted measures exclude specified compensation, TRA effects and ownership-structure impacts and are not substitutes for GAAP results.