Business context and reporting period
Artisan Partners Asset Management Inc. (APAM) is an active investment manager serving institutional and intermediary clients through separate accounts and pooled funds. This Form 10-K reports the fiscal year ended December 31, 2018; quarterly figures below identify the fourth quarter separately. Revenue is derived almost entirely from investment management fees, generally based on average assets under management (AUM).
Financial and operating performance
- Revenue: $828.6 million in 2018, up 4% from $795.6 million in 2017. Average AUM rose 4.6% to $113.8 billion; weighted-average fee edged down to 72.9 basis points from 73.1.
- Profitability: Operating income was $304.9 million, up 6%; GAAP operating margin was 36.8%, versus 36.0%. Adjusted operating margin declined to 36.8% from 37.6%. Net income attributable to APAM was $158.3 million, or $2.84 per share, compared with $49.6 million, or $0.75 per share, in 2017. Adjusted net income was $226.1 million, or $2.94 per adjusted share, versus $182.1 million, or $2.41.
- Cash flow: Operating cash flow was $333.3 million, compared with $226.0 million in 2017. Investing cash outflow was $14.3 million and financing cash outflow was $263.5 million. Year-end cash and cash equivalents were $160.5 million; this excludes cash held by consolidated investment products.
- Debt and liquidity: Borrowings were $200 million, with no draw on the $100 million revolving facility. $50 million of notes mature in August 2019; management intended to refinance them, or use excess cash if refinancing is unavailable. The company reported compliance with debt covenants.
- Other balance-sheet items: Total assets were $805.0 million, total liabilities $630.2 million, and the tax receivable agreement (TRA) liability $369.4 million. Deferred tax assets were $429.1 million.
- AUM and flows: Year-end AUM fell 16.7% to $96.2 billion, reflecting $11.9 billion of market depreciation and $7.4 billion of net client outflows. Fourth-quarter AUM declined 17%, including $4.9 billion of net outflows. Fourth-quarter revenue was $191.5 million, versus $210.7 million in Q4 2017; operating income was $64.2 million, versus $81.2 million.
Changes versus prior periods
- Despite higher average AUM and annual revenue, 2018 ended with substantially lower AUM after weak markets and continued net outflows. Outflows increased from $5.4 billion in 2017 to $7.4 billion in 2018.
- Annual GAAP net income increased sharply from 2017, but the comparison is distorted by 2017’s unusual tax effects: Tax Reform led to a $352 million reduction in deferred tax assets and a corresponding tax expense, partly offset by a $290.9 million TRA-related gain. Adjusted net income offers a less distorted comparison.
- Operating expenses rose 3% to $523.7 million. Compensation increased, while distribution, servicing and marketing expenses declined. Management cited investment in talent, technology, facilities, and new strategies as pressure on adjusted margin.
- Market indices were negative in 2018 after strong 2017 returns; for example, the MSCI ACWI returned -9.4% in 2018 versus +24.0% in 2017.
Outlook, commentary, risks and unusual items
- Management expects outflows from U.S. Mid-Cap Growth, U.S. Mid-Cap Value and Non-U.S. Growth to continue weighing on firm-wide flows. It also reported reopening certain strategies to new investors in early 2019 and continued to manage capacity in others.
- Management expected 2019 occupancy expense of about $22 million, including approximately $2 million of one-time office-exit costs, and communication and technology expense of about $40 million. Incremental expense for the Non-U.S. Small-Mid Growth team was expected to be approximately $4–$5 million in 2019, net of that team’s revenue share.
- Management expected approximately $25 million of TRA payments in 2019. The 2018 payment, including interest, was $36.2 million. The reported TRA liability and payment timing depend on taxable income, tax law, unit exchanges and other estimates; payments can accelerate in specified circumstances.
- In February 2019, the board declared a $0.56-per-share quarterly dividend and a $1.03 special dividend for the December 2018 quarter. Management described a target, subject to board approval, of quarterly dividends near 80% of cash generated; future dividends are not assured.
- Key risks include market declines reducing AUM and fee revenue, continued client withdrawals, investment underperformance, dependence on key portfolio managers, fee pressure and competition from passive products, regulatory and operational/cybersecurity risks, and foreign-exchange exposure. A 10% AUM change, assuming proportional effects across strategies, was estimated to change annualized revenue by about $70.1 million at the current average fee rate.
- Other notable matters: APAM deconsolidated a private fund in 2018, reducing reported cash by $39.8 million, with no net income impact. Management reported no legal proceedings expected to materially affect financial position, cash flows or results. The auditor issued unqualified opinions on the financial statements and internal controls.
Most important facts for investors to verify
- Whether net outflows persist, particularly in the three strategies identified by management, and how they affect average AUM and fees.
- Fourth-quarter and subsequent strategy performance, including whether the reported long-term outperformance is sustained; composite returns shown are gross of fees unless stated otherwise.
- Cash generation and dividend coverage after debt service, TRA payments, investment spending and other distributions.
- Refinancing or repayment of the $50 million notes due August 2019, and continued compliance with covenants.
- Assumptions and timing behind the $369.4 million TRA liability, deferred tax assets and future payments.
- Effect of the 2018 market decline and client flows on margins, compensation and 2019 operating costs.