Artisan Partners Asset Management Inc. quarterly report, Q2 FY2014

Full document

Artisan Partners Asset Management Inc. — Form 10-Q Summary

Business context and reporting period. Unaudited results cover the quarter and six months ended June 30, 2014. Artisan is an active investment manager with six investment teams and 14 strategies; substantially all revenue comes from investment management fees tied primarily to assets under management (AUM). APAM owned approximately 44% of Artisan Partners Holdings at June 30, with the balance reflected as noncontrolling interests.

Key financial metrics

  • AUM and flows: Period-end AUM was $112.0 billion, up 30.6% from $85.8 billion a year earlier. Q2 average AUM was $108.2 billion, up 26.8%; first-half average AUM was $107.2 billion, up 30.3%. Net client inflows were $558 million in Q2 and $2.0 billion for the first half. Market appreciation contributed $3.9 billion and $4.6 billion, respectively.
  • Revenue: Q2 revenue was $208.5 million, up 29% year over year; first-half revenue was $410.3 million, up 32%. The weighted average fee was 77 basis points, versus 76 basis points in the comparable periods.
  • Profit and margins: Q2 operating income was $80.8 million versus $48.4 million; reported operating margin was approximately 38.8% versus 29.9%. Net income before noncontrolling interests was $63.9 million; net income attributable to APAM was $19.3 million, or $0.42 per share, versus $5.8 million and $0.38 per share. First-half operating income was $148.0 million; net income before noncontrolling interests was $116.1 million and APAM-attributable net income was $27.9 million. First-half GAAP EPS was a loss of $1.64, reflecting $47.3 million of deemed dividends associated with preferred equity purchases/conversion, despite positive net income attributable to APAM. Management’s non-GAAP adjusted operating margin was 46.5% for Q2 and 45.8% for the first half; adjusted EPS was $0.84 and $1.62, respectively.
  • Cash flow: First-half operating cash flow was $235.1 million, investing cash outflow was $14.4 million, and financing cash outflow was $229.0 million. Cash and cash equivalents were $203.6 million at June 30, compared with $211.8 million at year-end. The company reported $65.0 million of accounts receivable and an undrawn $100 million revolving facility; liquidity figures exclude Launch Equity cash and receivables.
  • Debt and balance sheet: Borrowings were $200 million, unchanged from year-end, comprising unsecured notes with maturities in 2017, 2019 and 2022 and stated rates of 4.98%–5.82%. No revolver borrowings were outstanding, and the company reported compliance with debt covenants. Total assets were $932.6 million and total liabilities $808.2 million. Deferred tax assets were $538.4 million and amounts payable under tax receivable agreements (TRAs) were $463.8 million.

Material changes versus comparable periods

  • Revenue growth principally reflected higher average AUM. Q2 net inflows were lower than the prior-year quarter ($558 million versus $1.4 billion); first-half inflows also declined ($2.0 billion versus $3.6 billion). First-half market appreciation was lower than in 2013 ($4.6 billion versus $7.9 billion).
  • Q2 total operating expenses rose 12% to $127.7 million, including higher compensation and distribution, marketing, communication and technology costs. First-half operating expenses fell sharply from $683.1 million to $262.3 million, largely because the prior-year period included IPO-related and other pre-offering compensation charges, including a $287.3 million Class B award modification charge.
  • First-half reported GAAP results are not directly comparable with 2013: the prior-year period included substantial pre-offering charges and spans the March 2013 IPO/reorganization, while APAM’s share of Holdings earnings changed with its ownership interest.
  • APAM’s Holdings ownership increased from 29% at December 31, 2013 to 44% at June 30, 2014 following a March follow-on offering and subsequent unit/share exchanges and preferred equity conversion. No convertible preferred shares or Holdings preferred units remained outstanding at quarter-end.

Outlook, management commentary, risks and unusual items

  • Management gave no specific earnings or AUM forecast. It cited potential growth capacity particularly in certain non-U.S. and global strategies, while noting that AUM and results depend on investment performance, client flows, markets, competition and the ability to attract and retain investment professionals. Seven strategies were closed to most new investors as of the filing date.
  • A $722 million separate-account client termination in March contributed to first-half separate-account net outflows of $656 million. Management said the termination reflected the client’s consolidation and cost-reduction decisions and illustrates that flows can be lumpy.
  • The company targets distributing the majority of annual adjusted earnings through quarterly dividends and, subject to profitability and business conditions, a special annual dividend; future dividends are not assured. A $0.55 per-share quarterly dividend and $35.4 million Holdings distribution were declared in July for payment in August 2014.
  • The $463.8 million TRA liability is an estimate; payments generally transfer 85% of applicable realized or deemed tax savings to counterparties. Payments may be accelerated and could exceed realized tax benefits in certain circumstances. The company expected approximately $4.6 million of TRA payments in 2014, funded by realized tax benefits.
  • Other unusual or forward-looking items include July 2014 approval of 1,403,146 restricted shares, with expected compensation expense of approximately $73.1 million over the service period, and an expected approximately $1.5 million increase in quarterly distribution expenses beginning in Q3 2014, potentially partly offset by lower intermediary fees over time.
  • Management reported no material legal or administrative proceedings, no off-balance-sheet arrangements, effective disclosure controls, and no material change in internal control over financial reporting. Indemnification exposure is not quantifiable; the filing refers investors to the 2013 Form 10-K risk factors.

Most important facts for investors to verify

  • Whether AUM growth can persist as net inflows have slowed and performance and market conditions affect fee revenue.
  • The effect of the large separate-account termination, strategy closures and concentration of AUM across strategies and distribution channels.
  • The drivers and sustainability of reported earnings, particularly the first-half GAAP EPS loss versus positive APAM-attributable net income and management’s non-GAAP adjustments.
  • The amount, timing and potential acceleration of TRA payments, and the realizability of the related deferred tax assets.
  • Future compensation, equity-award and distribution costs, dividend capacity, and compliance with debt covenants and other contractual obligations.