AMG

Business Context and Reporting Period

Company: Affiliated Managers Group, Inc. (AMG)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2002
Business Overview: AMG is an asset management holding company with equity investments in a diverse group of mid-sized investment management firms ("Affiliates"). As of December 31, 2002, Affiliates managed approximately $70.8 billion in assets across three principal distribution channels: High Net Worth, Mutual Fund, and Institutional. The company's strategy focuses on internal growth and acquiring majority equity interests in mid-sized firms while preserving their entrepreneurial culture.

Key Financial Metrics

Note: Net Income for 2002 reflects the adoption of FAS 142, which eliminated the amortization of goodwill and certain intangible assets, making it not directly comparable to prior periods without adjustment.

Material Changes vs. Prior Period

• Revenue Growth: Revenue increased 18% to $482.5 million, driven primarily by new investments in Third Avenue Management (acquired Q3 2002), Friess Associates, and Welch & Forbes (acquired Q4 2001), as well as higher performance fees. This growth occurred despite a 12.6% decline in total AUM due to broad equity market declines.
• Net Income: Net Income rose 12% to $55.9 million. The increase was bolstered by revenue growth and a significant reduction in amortization expense ($14.5 million in 2002 vs. $28.4 million in 2001) due to the adoption of FAS 142.
• Operating Expenses: Total operating expenses increased 13% to $286.7 million. Compensation and related expenses rose 23% due to new acquisitions and distribution initiatives. However, amortization of intangible assets dropped 49% due to the new accounting standard.
• Interest Expense: Interest expense surged 71% to $25.2 million, primarily due to the issuance of mandatory convertible debt securities in late 2001 and early 2002.
• Segment Performance:
  • Mutual Fund: Revenue increased 45% and Net Income 46%, driven by asset growth from new acquisitions.
  • High Net Worth: Revenue increased 4%, but Net Income declined 10%.
  • Institutional: Revenue increased 11%, while Net Income remained relatively flat (up 3%).

Guidance, Outlook, Risks, and Unusual Items

Outlook and Capital Needs

Management anticipates continued industry growth driven by demographics and GDP, though performance remains tied to equity market conditions. The company expects to need additional capital for future acquisitions, repurchasing affiliate equity (put rights), and servicing debt. In February 2003, AMG issued $300 million of floating rate senior convertible securities to fund these obligations.

Key Risks and Contingencies

• Market Risk: Revenue is directly tied to AUM, which fluctuates with equity market performance. Declines in markets reduce asset-based fees and performance fees.
• Debt Obligations: AMG has significant repurchase obligations for zero coupon senior convertible notes (first put date May 2004) and floating rate senior convertible securities. The company intends to fund these with cash, which may restrict liquidity for new investments.
• Intangible Assets: Approximately 90% of total assets ($1.1 billion) are intangible (goodwill and client relationships). These are subject to annual impairment testing under FAS 142.
• Key Personnel: The business relies heavily on the retention of key investment managers at Affiliates. Departures could lead to client attrition.
• Regulatory: Affiliates are highly regulated by the SEC and other bodies; non-compliance could result in sanctions or loss of registration.

Unusual Items

The adoption of FAS 142 in 2002 eliminated the amortization of goodwill, significantly boosting reported Net Income compared to prior years. Additionally, the company repurchased $111.5 million of zero coupon senior convertible notes in privately negotiated transactions subsequent to December 31, 2002.

Investor Verification Checklist

• FAS 142 Impact: Verify the pro forma Net Income and EBITDA for 2001 and 2000 as if FAS 142 had been adopted earlier to ensure accurate year-over-year trend analysis.
• Debt Repurchase Dates: Confirm the company's liquidity position relative to the May 2004 repurchase date for zero coupon notes and the February 2008 date for floating rate securities.
• Acquisition Integration: Assess the performance of Third Avenue Management (acquired Q3 2002) and Friess Associates to determine if they are meeting revenue and cash flow projections.
• Intangible Asset Valuation: Review the annual impairment testing results for goodwill and indefinite-lived intangible assets, given they comprise the vast majority of the balance sheet.
• Put Rights Obligations: Monitor the estimated $575.6 million obligation to purchase additional equity in Affiliates and the company's ability to fund these without diluting shareholders or increasing leverage excessively.