Artisan Partners Asset Management Inc. quarterly report, Q1 FY2013

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Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2013, for Artisan Partners Asset Management Inc. (APAM). The reporting period is significantly impacted by the company's Initial Public Offering (IPO) and related corporate reorganization, which closed on March 12, 2013. Prior to this date, APAM was a subsidiary of Artisan Partners Holdings LP; post-IPO, APAM became the sole general partner and consolidates the financial statements of Holdings. The company operates as an independent investment management firm with five autonomous teams managing twelve distinct strategies.

Key Financial Metrics

Metric Q1 2013 Q1 2012
Total Revenues $148.2 million $119.7 million
Operating Expenses $569.5 million $115.3 million
Operating Income (Loss) ($421.3 million) $4.4 million
Net Income Attributable to APAM $3.0 million $0
Assets Under Management (AUM) $83.2 billion $66.5 billion
Cash and Cash Equivalents $199.1 million $141.2 million
Total Borrowings $200.0 million $290.0 million

Margin Analysis: The company reported a GAAP operating loss of $421.3 million, primarily driven by non-recurring pre-offering compensation expenses. Management reports a Non-GAAP Adjusted Operating Margin of 37.0% for the quarter, compared to 39.6% in the prior year.

Material Changes vs. Prior Period

  • Revenue Growth: Revenues increased 24% year-over-year to $148.2 million, driven by a 25.8% increase in average AUM to $79.2 billion. This growth was fueled by $6.7 billion in market appreciation and $2.2 billion in net client cash inflows.
  • Expense Surge: Total operating expenses increased 394% to $569.5 million. This was almost entirely due to pre-offering related compensation totaling $476.3 million, including a $287.3 million non-recurring charge for the modification of Class B share-based awards and $56.8 million in cash incentives to portfolio managers.
  • Debt Reduction: Borrowings decreased by $90 million to $200 million. The company used IPO proceeds to fully repay the $90 million outstanding balance on its revolving credit facility.
  • Non-Operating Gains: The company recorded a $24.8 million gain on the valuation of Contingent Value Rights (CVRs), reflecting a decrease in the fair value of the liability due to the increase in APAM's stock price post-IPO.

Guidance, Outlook, and Risks

  • Capital Allocation: Net IPO proceeds of $353.4 million were utilized for retained profit distributions ($105.3 million), debt repayment ($90.0 million), and the purchase of Class A common units ($76.3 million). Remaining proceeds are for general corporate purposes.
  • Future Expenses: Management anticipates increased general and administrative expenses associated with being a public company, including compliance, insurance, and legal fees. They also expect significant costs related to obtaining client consents for the change of control in 2014.
  • Tax Receivable Agreements (TRAs): APAM has recorded a $53.4 million liability for TRAs, requiring the company to pay 85% of cash tax savings realized from the IPO to certain partners. Actual payments depend on future taxable income and exchange activity.
  • Contingent Value Rights (CVRs): A liability of $30.6 million exists for CVRs, which may require a cash payment up to $100 million in 2016 or upon a change of control, depending on the stock price.
  • Market Risk: A 10% decline in AUM would result in an approximate $63.2 million annualized decrease in revenues. The company does not hedge market risks at the corporate level.

Investor Verification Checklist

  • Non-GAAP Reconciliation: Verify the calculation of "Adjusted Net Income" ($33.2 million) and "Adjusted Operating Income" ($54.9 million) to understand underlying operational performance excluding IPO-related charges.
  • Compensation Structure: Review the details of the Class B award modification ($287.3 million charge) and the vesting schedule for remaining unvested awards ($224.7 million unrecognized expense) to assess future non-cash compensation impacts.
  • TRA and CVR Liabilities: Monitor the assumptions used for the Tax Receivable Agreements and Contingent Value Rights, as these represent significant contingent cash outflows dependent on future stock performance and tax realizations.
  • AUM Flows: Analyze the sustainability of the $2.2 billion in net inflows, noting that the Emerging Markets strategy experienced outflows due to a large client termination.
  • Debt Covenants: Confirm compliance with financial covenants (leverage and interest coverage ratios) on the remaining $200 million in senior notes.