Artisan Partners Asset Management Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. Unaudited consolidated financial statements; comparisons are to the corresponding 2017 periods unless noted. Artisan is an active investment manager operating through Artisan Partners Holdings LP; APAM owned approximately 70% of Holdings at quarter-end.
Business context and performance
Artisan managed $114.2 billion of assets at June 30, 2018, across eight investment teams and 17 strategies. Approximately 80% of AUM was for U.S.-domiciled clients and 20% for clients outside the U.S. Management says long-term investment performance is a key business driver and that results can be uneven as markets and AUM fluctuate.
- Q2 AUM declined $626 million from March 31, reflecting $339 million of net client outflows and $287 million of market depreciation. Versus June 30, 2017, AUM was up $4.8 billion, or 4.4%, mainly due to market appreciation.
- First-half net client outflows were $942 million, versus $1.8 billion in the first half of 2017. Outflows were concentrated in Growth and U.S. Value teams; Global Value, Credit, Developing World and Thematic had net inflows.
- Management reported that 12 of 14 strategies with at least a one-year track record outperformed their broad-based benchmarks since inception, net of fees. The detailed performance table in the filing reports gross composite returns, which are not the same as client net returns.
Financial results and liquidity
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Revenue | $212.3 million | $196.3 million | $424.3 million | $380.3 million |
| Operating income | $78.9 million | $66.5 million | $158.9 million | $124.5 million |
| GAAP operating margin | 37.2% | 33.9% | 37.4% | 32.7% |
| Net income attributable to APAM | $42.0 million | $26.6 million | $83.3 million | $46.4 million |
| GAAP diluted EPS | $0.72 | $0.45 | $1.48 | $0.86 |
| Operating cash flow | Not separately stated | Not separately stated | $241.0 million | $196.5 million |
- Q2 revenue rose 8%; first-half revenue rose 12%. Higher average AUM was the main driver. First-half average AUM increased 12.3% to $117.0 billion. Performance-fee revenue was $2.3 million in first-half 2018, versus $0.3 million in 2017.
- First-half operating expenses increased 4% to $265.4 million. Compensation and benefits rose 5% to $212.0 million, reflecting higher incentive compensation and equity awards; the increase was partly offset by the absence of pre-offering compensation expense recorded in 2017.
- First-half adjusted operating margin, a non-GAAP measure, was 37.4%, versus 36.1%. Adjusted net income was $117.9 million and adjusted net income per adjusted share was $1.53, compared with $83.1 million and $1.10, respectively. These measures assume full exchange of Holdings units and full vesting of awards; see the filing’s reconciliation.
- First-half effective tax rate fell to 14.8% from 23.3%, principally following the federal corporate tax-rate reduction from 35% to 21% under Tax Reform. Management’s estimated adjusted effective tax rate was 23.5% versus 37.0%.
- Cash and cash equivalents were $190.4 million at June 30, versus $137.3 million at year-end 2017. The company reported $237.6 million of cash, cash equivalents and restricted cash including consolidated investment products. First-half cash flow was $241.0 million from operations, $(2.8) million from investing and $(160.4) million from financing.
- Debt principal was $200.0 million in senior notes; the balance-sheet carrying amount was $199.2 million. Notes mature in 2019 ($50 million), 2022 ($90 million) and 2025 ($60 million). The $100 million revolving facility was undrawn, and the company reported compliance with debt covenants.
- Amounts payable under tax receivable agreements (TRAs) were $377.5 million, down from $385.4 million at year-end. APAM paid $27.3 million under the TRAs in the first half.
Material changes, outlook and risks
- APAM completed a February 2018 follow-on offering and Holdings unit exchanges; its ownership of Holdings increased from 67% at December 31, 2017 to approximately 70% at June 30, 2018. Higher APAM ownership can increase the share of Holdings income subject to corporate tax.
- Management expected outflow trends in U.S. Mid-Cap Growth, U.S. Mid-Cap Value and Non-U.S. Growth to continue further into 2018. Several strategies were closed or restricted to most new investors to manage capacity.
- APAM declared a $0.60 quarterly Class A dividend after quarter-end, payable August 31, 2018. Management said it currently expected quarterly dividends during 2018, subject to board approval; the board was considering changes to the dividend policy, including a variable quarterly dividend. A special dividend would be considered after year-end and was not assured.
- Management expected approximately $36 million of TRA payments in 2018, including $27.3 million already paid, and approximately $25 million in 2019. TRA payments depend on tax benefits, taxable income, ownership exchanges and tax rates; in some cases payments may be accelerated or exceed benefits actually realized.
- Key risks cited include adverse market or economic conditions, poor investment performance, loss of key investment professionals or senior management, regulatory or legislative changes, and operational or technical failures. The filing reported no material legal proceedings, no material off-balance-sheet arrangements, and no material changes to market-risk disclosures.
- Adoption of the new revenue standard had no material effect on operating or net income. The company was evaluating the lease-accounting standard effective in 2019, which it expected to increase reported assets and liabilities significantly without a significant income-statement impact.
Important facts for investors to verify
- Whether AUM flows improve or worsen, particularly in the strategies with reported outflows, and how market performance affects fee revenue.
- Strategy performance using comparable net-of-fee results, rather than relying solely on the filing’s gross composite returns or management’s summary.
- The sustainability of margins and earnings after separating recurring operating performance from investment gains, tax-rate effects and equity-compensation costs.
- Cash available to APAM for dividends after Holdings distributions, debt service and TRA payments; distinguish corporate cash from cash held by consolidated investment products.
- TRA payment estimates and assumptions, debt maturities and covenant compliance, as well as any eventual change to the dividend policy.