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, 2017. Results are consolidated; APAM owned approximately 66% of Artisan Partners Holdings at quarter-end, with the remainder reflected as noncontrolling interests.
Assets under management (AUM) reached a record $113.7 billion, up 13.9% year over year. The increase reflected market appreciation; net client flows remained negative.
Key financial metrics
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $204.6 million | $184.1 million | $584.9 million | $539.4 million |
| Operating income | $80.6 million | $61.9 million | $205.2 million | $175.6 million |
| GAAP operating margin | 39.4% | 33.6% | 35.1% | 32.6% |
| Adjusted operating margin (non-GAAP) | 39.4% | 37.3% | 37.2% | 36.6% |
| Net income attributable to APAM | $30.7 million | $19.1 million | $77.1 million | $53.7 million |
| Basic and diluted EPS | $0.61 | $0.41 | $1.48 | $1.15 |
| Net client cash flows | $(1.2) billion | $(0.9) billion | $(3.0) billion | $(4.6) billion |
| Average AUM | $111.4 billion | $98.2 billion | $106.6 billion | $95.9 billion |
Management fees drove nearly all revenue. The weighted average fee declined to 72.9 basis points in Q3 from 74.5 basis points, and to 73.3 basis points for the nine months from 75.0 basis points, mainly due to a shift in the mix of strategies and vehicles.
For the nine months, operating cash flow was $249.6 million, investing cash outflow was $3.2 million, and financing cash outflow was $200.6 million. Cash and cash equivalents were $202.6 million at September 30, versus $156.8 million at year-end 2016. The company reported a $100 million undrawn revolving facility.
Borrowings had a $200 million contractual principal balance ($198.9 million carrying value). The company refinanced $60 million of notes maturing in August 2017 with new 4.29% Series D notes due in 2025, and extended its $100 million revolver through August 2022. It reported compliance with debt covenants.
Material changes versus the prior period
- Q3 revenue rose 11% year over year, primarily as average AUM increased 13.4%; the lower fee rate partly offset that growth. Nine-month revenue rose 8%.
- Q3 operating income increased 30% and APAM-attributable net income increased 61%. Nine-month operating income increased 17% and APAM-attributable net income increased 44%.
- Year-to-date AUM rose $16.8 billion from year-end 2016, principally from $19.8 billion of market appreciation, partly offset by $3.0 billion of net outflows.
- APAM’s ownership of Holdings increased from 57% to 66%, following a February follow-on offering, partnership-unit exchanges, and other equity transactions. Weighted-average Class A shares also increased, affecting per-share comparisons.
- All pre-offering Class B awards became fully vested by July 1, 2017; the associated compensation expense fell year over year. Current restricted-share compensation increased.
Outlook, commentary, risks and unusual items
- Management expects continued net outflows in Non-U.S. Growth and Mid-Cap Growth, and continued net inflows in Global Opportunities, Developing World and High Income. Several strategies remain closed or restricted to most new investors to manage capacity.
- Management estimated November 2017 Artisan Funds income and capital-gains distributions could cause about $450 million of net client outflows from investors who do not reinvest, compared with approximately $294 million in November 2016.
- Subject to quarterly board approval, management expected a $0.60 quarterly Class A dividend during 2017. The board declared a $0.60 dividend after quarter-end, payable November 30, 2017. A possible special dividend would depend on annual adjusted earnings, business conditions and desired cash retention; it was not assured.
- The tax receivable agreement (TRA) liability was $666.6 million, up from $586.2 million at year-end. APAM generally owes counterparties 85% of applicable tax savings. Payments may vary, and in certain cases may be accelerated or exceed realized benefits; $30.2 million was paid in the first nine months, with no further 2017 payment planned.
- Results remain sensitive to market conditions, investment performance, client flows, fee and asset mix, and retention of key professionals. Management cautioned that interim results are not necessarily indicative of full-year performance. It provided no specific earnings or AUM guidance.
- Management expected the 2018 revenue-recognition standard to have no material financial-statement impact. The 2019 lease standard was expected to increase reported assets and liabilities significantly, without a significant effect on the income statement.
- No material legal proceedings, material off-balance-sheet arrangements, or material changes in market-risk disclosures were reported. Management concluded disclosure controls were effective.
Important facts for investors to verify
- Whether strong market-driven AUM growth can offset continuing net client outflows, especially in the two strategies management expects to remain in outflow.
- How AUM mix and the weighted average fee rate evolve, and whether operating-margin improvement is sustained after compensation and other costs.
- The cash generation available for dividends and distributions after TRA payments, and the assumptions and timing behind the $666.6 million TRA liability.
- The effect of the increased Class A share count and APAM’s higher ownership of Holdings on future reported earnings, taxes and per-share results.
- The scale and actual cash impact of the expected November fund distributions; the $450 million estimate depends on investor reinvestment choices.