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, 2018. The firm reported $116.6 billion in period-end assets under management (AUM), managed by eight investment teams across 17 strategies. About 80% of AUM was for U.S.-domiciled clients and 20% for clients domiciled outside the U.S.
Financial and operating results
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $212.8 million | $204.6 million | $637.1 million | $584.9 million |
| Operating income | $81.8 million | $80.6 million | $240.7 million | $205.2 million |
| Operating margin | 38.5% | 39.4% | 37.8% | 35.1% |
| Net income attributable to APAM | $42.5 million | $30.7 million | $125.8 million | $77.1 million |
| Basic and diluted EPS | $0.77 | $0.61 | $2.27 | $1.48 |
| Dividends declared per Class A share | $0.60 | $0.60 | $2.59 | $2.16 |
For the nine months, adjusted operating margin, a non-GAAP measure, was 37.8% versus 37.2%; adjusted net income per adjusted share was $2.32 versus $1.75. The filing cautions that non-GAAP measures supplement, and do not replace, GAAP results.
Average AUM rose 4% year over year in Q3 to $116.2 billion and 10% for the nine-month period to $116.8 billion. The weighted average fee was 72.7 basis points in Q3 and 73.0 basis points for the nine months, down from 72.9 and 73.3 basis points, respectively. Net client cash outflows were $1.5 billion in Q3 and $2.5 billion for the nine months. Q3 AUM growth reflected $3.9 billion of market appreciation, partly offset by outflows.
Nine-month operating cash flow was $328.2 million, versus $268.7 million. Investing cash use was $9.1 million and financing cash use was $211.6 million. Cash, cash equivalents and restricted cash totaled $227.6 million, including $211.4 million of company cash and cash equivalents and $15.5 million held by consolidated investment products. The latter is not available for general corporate purposes.
Borrowings were $200 million in principal: $50 million of notes due in 2019, $90 million due in 2022 and $60 million due in 2025. The $100 million revolving credit facility was undrawn; the company reported compliance with its debt covenants. The balance sheet reported $199.3 million of borrowings.
Material changes versus prior comparable periods
- Nine-month revenue increased 9%, mainly reflecting higher average AUM; operating income increased 17% and APAM-attributable net income increased 63%.
- Q3 revenue increased 4%, while operating income increased 1%; Q3 operating margin declined 0.9 percentage points.
- The nine-month effective tax rate fell to 15.7% from 24.7%, primarily following the reduction in the U.S. federal corporate tax rate from 35% to 21% under Tax Reform. The Q3 rate was 17.5% versus 26.9%.
- Nine-month results included $9.5 million of investment gains from consolidated investment products and $2.5 million of net investment income; these non-operating items were higher than in 2017. The 2017 comparison also included $12.7 million of pre-offering share-based compensation that did not recur.
- APAM’s ownership of Artisan Partners Holdings increased from 67% at year-end 2017 to approximately 70% at September 30, 2018, partly through unit exchanges and a follow-on offering.
Outlook, management commentary, risks and unusual items
Management said results can be volatile with markets and AUM, and expects near-term outflow trends to continue in certain strategies. The firm anticipated approximately $850 million of net outflows in November 2018 from annual fund distributions for investors who do not reinvest, compared with approximately $510 million in November 2017. Several strategies remained closed or restricted to most new investors to manage capacity.
After quarter-end, AUM declined to approximately $104 billion by October 29, 2018, primarily due to a sharp fall in global equity markets. Management noted that many expenses, including much investment-team compensation, vary with revenue and AUM. It expected approximately $5 million of incremental Q4 2018 expense related to Global Equity team hires, with future quarterly net expense estimated at approximately $1.2 million before any reduction as the strategy grows. Occupancy expense was expected to be approximately $5 million in Q4, including relocation-related costs.
APAM declared a $0.60 quarterly dividend payable November 30, 2018. Subject to board approval, management expected to continue quarterly dividends during 2018 and said the board would consider a special dividend after year-end. The company planned to begin a variable quarterly dividend in Q1 2019, targeted at approximately 80% of cash generated in the prior quarter; dividends remain subject to board approval and may change or not be paid.
The tax receivable agreement (TRA) liability was $369.0 million at September 30, 2018. APAM paid $36.1 million under the TRAs during the nine months and expected approximately $25 million of payments in 2019; timing and amounts are subject to estimates and could vary. In some cases, TRA payments may be accelerated or exceed realized tax benefits. A private investment fund was deconsolidated in Q3 after third-party contributions changed the control assessment; the filing reported no net income-statement impact, but cash and cash equivalents decreased by $39.8 million due to deconsolidation.
Key risks cited include adverse markets or economic conditions, weak investment performance, client outflows, loss of key investment professionals, regulatory changes, and operational or technical failures. Management reported no legal or administrative proceedings believed to be material, no material off-balance-sheet arrangements, and effective disclosure controls as of September 30, 2018. The filing says the upcoming lease standard is expected to significantly increase assets and liabilities, without a significant income-statement impact.
Important facts for investors to verify
- Whether market declines and strategy-specific outflows persist, particularly given the reported post-quarter AUM decrease and anticipated fund distributions.
- How AUM, fee rates and investment performance evolve, including the impact of strategy capacity limits and the lower weighted average fee.
- Whether the planned variable dividend and any special dividend are approved and supported by cash generation, after distributions, dividends and TRA payments.
- The timing and amount of TRA obligations, and the assumptions underlying the $369.0 million liability and projected 2019 payments.
- The sustainability of earnings growth after considering lower tax rates, investment gains, equity compensation and the 2017 nonrecurring compensation comparison.