Artisan Partners Asset Management Inc. — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014. The unaudited consolidated statements include Artisan Partners Holdings; APAM held approximately 47% of Holdings’ economic interests at quarter-end, with the remainder reported as noncontrolling interests. Year-to-date 2013 comparisons are affected by the March 2013 IPO and related reorganization.
Business context and operating results
Artisan is an active investment manager with six investment teams and 14 strategies. It earns nearly all revenue from management fees, generally based on client assets under management (AUM). At September 30, 2014, AUM was $106.2 billion, including 12% from non-U.S. clients.
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Prior comparable period |
|---|---|---|---|---|
| Revenue | $212.4 million | $178.1 million | $622.7 million | $488.2 million |
| Operating income (loss) | $81.0 million | $53.4 million | $229.0 million | $(319.6) million |
| Net income attributable to APAM | $20.4 million | $6.0 million | $48.3 million | $14.7 million |
| Basic/diluted EPS | $0.57 / $0.57 | $0.42 / $0.35 | $(1.02) / $(1.02) | $0.97 / $0.90 |
| Adjusted operating margin (non-GAAP) | 44.0% | 43.3% | 45.2% | 41.8% |
| Adjusted net income (non-GAAP) | $57.4 million | $47.6 million | $173.4 million | $125.3 million |
| Adjusted EPS (non-GAAP) | $0.79 | $0.67 | $2.41 | $1.77 |
Q3 GAAP operating margin was approximately 38.1%, versus 30.0% a year earlier. Revenue rose 19% in Q3 and 28% year to date, primarily reflecting higher average AUM: $110.2 billion in Q3 and $108.2 billion year to date. Weighted average fees were 76 basis points in Q3 and 77 basis points year to date.
Material changes and AUM
- Q3 AUM declined by $5.8 billion from the quarter’s start to $106.2 billion, including $5.1 billion of market depreciation and $645 million of net client outflows. Average AUM nevertheless increased 19% year over year.
- For the first nine months, net inflows of $1.3 billion were more than offset by $0.5 billion of market depreciation. Net inflows were lower than the $5.7 billion reported in the prior comparable period.
- Management attributed Q3 outflows to lower seasonal inflows, client rebalancing and performance challenges in U.S. Value and Emerging Markets strategies. Net outflows were concentrated in several U.S. strategies; Non-U.S. Growth, Global Equity and Global Opportunities were among the Q3 inflow leaders.
- Several strategies were closed to most new investors to manage investment capacity. Management identified certain non-U.S. and global strategies, and the new High Income strategy, as areas with potential capacity or demand.
- Q3 compensation and benefits were broadly flat at $103.2 million; other operating expenses increased 30% to $28.2 million, principally from distribution, marketing, technology and consulting costs.
The nine-month GAAP operating result improved sharply from a loss to income, but the comparison is distorted by 2013 IPO-related compensation charges, including a $287.3 million award-modification expense and other pre-offering compensation. 2014 included $52.2 million of amortization on pre-offering awards. 2013 non-operating results also included a $40.4 million CVR valuation gain; the CVRs were terminated in November 2013. In 2014, the TRA estimate change contributed $4.2 million of non-operating expense year to date, partly offset by a $4.1 million discrete tax benefit.
Despite positive nine-month net income attributable to APAM, GAAP EPS was a loss of $1.02, primarily because $49.2 million of deemed dividends related to preferred equity purchases, together with allocations to participating securities, reduced income available to common shareholders.
Cash flow, debt and liquidity
- Operating cash flow was $326.1 million for the first nine months, versus $117.8 million; investing cash flow was $(11.4) million and financing cash flow was $(298.5) million. Cash increased $16.1 million to $228.0 million.
- Management’s liquidity presentation excludes Launch Equity assets: $228.0 million of cash, $67.5 million of receivables and an undrawn $100 million revolving facility at September 30.
- Total borrowings were $200 million, all unsecured notes: $60 million due 2017 at 4.98%, $50 million due 2019 at 5.32%, and $90 million due 2022 at 5.82%. The revolver was undrawn, and Artisan reported compliance with debt covenants.
- Balance-sheet total assets were $984.0 million and total liabilities $837.6 million. These include $563.4 million of deferred tax assets and $486.5 million payable under tax receivable agreements (TRAs).
- Holdings distributed $329.7 million to its partners during the nine-month period; APAM paid $81.0 million in dividends. The board subsequently declared a $0.55-per-share quarterly dividend and a $27.2 million Holdings distribution.
Outlook, risks and contingencies
No quantified earnings, AUM or revenue guidance is provided. Management expects to distribute a significant portion of profits and targets distributing a majority of annual adjusted earnings through quarterly dividends and, subject to profitability and business conditions, a special annual dividend; distributions are not assured. Management noted that market performance, investment results, client flows, fee rates, competition, talent retention and strategy capacity can materially affect AUM and results. Global markets were weaker late in Q3, disproportionately affecting ending AUM relative to average AUM.
TRAs generally require APAM to remit 85% of specified realized or deemed tax savings. The $486.5 million recorded liability is an estimate; future amounts and timing depend on taxable income, tax rates, exchanges and other factors. Payments can in certain circumstances be accelerated or exceed realized tax benefits, potentially requiring cash on hand or borrowing. Management expects ordinary payments to be funded by tax savings. The company reported no material legal or administrative proceedings, no off-balance-sheet arrangements, and effective disclosure controls. It cautioned that interim results are not necessarily indicative of full-year results.
Investor verification points
- Track subsequent AUM flows and investment performance, particularly in strategies experiencing outflows or performance challenges.
- Assess the impact of lower market levels, client concentration, closed strategies and fee-rate/product mix on future revenue.
- Review the assumptions, potential payment timing and cash consequences of the $486.5 million TRA liability and related deferred tax assets.
- Distinguish reported GAAP results from adjusted non-GAAP results and account for the IPO-related 2013 comparison items and 2014 deemed dividends.
- Monitor compensation costs and dilution from restricted-share awards; the July 2014 awards carried expected compensation expense of approximately $72.2 million.
- Confirm dividend and partnership-distribution capacity against operating cash needs, debt covenants and future TRA payments.