Business context and reporting period
Artisan Partners Asset Management Inc. filed this unaudited Form 10-Q for the quarter ended September 30, 2013. Artisan is an active investment manager whose revenue is principally management fees tied to client assets under management (AUM). The March 12, 2013 IPO and reorganization changed the company’s ownership and tax structure: APAM held approximately 24% of Artisan Partners Holdings’ economics at quarter-end, with the balance reflected as noncontrolling interest. Accordingly, reported periods include substantial one-time restructuring and compensation items, and APAM’s attributable results are not directly comparable with pre-IPO periods.
Financial and operating highlights
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Revenue | $178.1 million | $128.1 million | $488.2 million | $368.5 million |
| GAAP operating income (loss) | $53.4 million | $(38.2) million | $(319.6) million | $7.7 million |
| Net income (loss) before noncontrolling interests | $56.1 million | $(36.0) million | $(296.3) million | $5.6 million |
| Net income attributable to APAM | $6.0 million | — | $14.7 million | — |
| Basic / diluted EPS | $0.42 / $0.35 | Not presented | $0.97 / $0.90 | Not presented |
| Adjusted operating margin (non-GAAP) | 43.3% | 38.9% | 41.8% | 40.0% |
| Adjusted net income (non-GAAP) | $47.6 million | $29.1 million | $125.3 million | $88.4 million |
Q3 revenue rose 39%, principally reflecting 38.2% higher average AUM of $92.4 billion; the weighted-average management fee remained 76 basis points. Nine-month revenue increased 32% as average AUM grew 32.9% to $85.7 billion. At September 30, AUM was $96.9 billion, up 38.8% year over year, reflecting $7.2 billion of year-to-date net inflows and $19.9 billion of market appreciation. Eleven of 13 strategies had net inflows during the quarter and year to date.
The nine-month GAAP operating loss primarily reflects IPO/reorganization-related compensation, including a $287.3 million charge from modifying Class B awards, $56.8 million of IPO-triggered cash incentives, and $20.5 million of bonus make-whole compensation. Nine-month total compensation and benefits was $745.0 million, versus $305.5 million a year earlier. Management’s non-GAAP measures exclude specified pre-offering compensation, proxy expenses, CVR valuation changes and certain ownership-structure effects; they are not substitutes for GAAP results.
Operating cash flow was $117.8 million for the nine months, compared with $138.4 million in 2012. The 2013 figure includes substantial noncash share-based compensation and increased accrued incentive compensation. Investing activities used $7.0 million and financing activities provided $24.0 million, including IPO proceeds. Cash and cash equivalents available to the company, excluding Launch Equity, were $275.9 million at September 30, versus $141.2 million at year-end 2012.
Total borrowings were $200.0 million, comprising fixed-rate senior notes due in 2017, 2019 and 2022; the $100 million revolving facility was undrawn. The company reported $54.0 million payable under tax receivable agreements (TRAs), and $64.8 million of deferred tax assets. Total assets were $541.8 million and total liabilities were $445.8 million at quarter-end. The consolidated balance sheet includes Launch Equity assets and liabilities, which are not generally available to APAM’s creditors and are not treated by management as a source of company liquidity.
Material changes versus the prior comparable period
- Higher AUM and market appreciation lifted quarterly and year-to-date fee revenue; net inflows also improved versus the comparable 2012 periods.
- Q3 operating income improved from a loss to profit, partly because 2012 included Class B liability-award remeasurement and distributions treated as compensation. Nine-month GAAP results moved to a large loss because of IPO/reorganization charges, despite higher revenue.
- APAM became a public company in March 2013 and began recording corporate income taxes on its share of Holdings income. Approximately 76% of Holdings’ earnings remained outside corporate-level tax at the time of filing.
- Debt declined from $290 million at December 31, 2012 to $200 million after repayment of the $90 million revolver balance with IPO proceeds. Liquidity increased substantially following the IPO.
Outlook, commentary, risks and unusual items
- Management said it expected to continue quarterly dividends and consider an additional special dividend each year. Subject to board discretion, it expected a quarterly and special dividend in Q1 2014, with the aggregate distribution and dividend expected to approximate excess cash after working capital needs and a $100 million reserve.
- On November 6, 2013, APAM completed a follow-on offering of 5.52 million Class A shares and used the net proceeds to purchase Holdings preferred units and convertible preferred stock. The transaction increased APAM’s Holdings ownership from 24% to 29%, terminated the CVRs without payment, and was not reflected in the September 30 statements. The company expected to record approximately $122.6 million of additional deferred tax assets and $104.2 million of additional TRA liability in Q4.
- The board declared a $0.43 per-share dividend for November 2013. Management expected $2–$3 million of client/fund approval and consent costs through early 2014 related to an anticipated change of control, and $1–$2 million of costs related to the November offering.
- The U.S. Small-Cap Growth strategy was closed to most new investors in August 2013. Management said it may close or restrict strategies to protect clients’ investment opportunities, even if that limits AUM growth.
- Results are sensitive to equity-market performance, client flows, investment performance, fee mix, currency movements and retention of investment professionals. Management estimated that a 10% AUM change would affect annualized revenue by about $73.7 million at the current average fee rate. It identified no material change to previously disclosed risk factors.
- The company reported no pending or known threatened legal proceedings, no off-balance-sheet arrangements, and effective disclosure controls. Debt agreements contain leverage and interest-coverage covenants; a breach could permit acceleration. TRA payments depend on tax savings and taxable income and in some circumstances may be accelerated or exceed realized benefits.
Most important facts for investors to verify
- Reconcile GAAP losses to adjusted results, especially the $287.3 million Class B modification expense and other IPO-related compensation, and assess the recurring compensation burden.
- Track AUM flows and market-driven growth separately, including the strategy-level outflows and the effect of closing the Small-Cap Growth strategy to most new investors.
- Review the November 6 offering’s actual proceeds, resulting ownership and share dilution, and subsequent accounting for CVR termination and TRA/deferred-tax changes.
- Confirm future dividend and Holdings distribution decisions against cash needs, debt covenants, tax obligations and the stated $100 million cash reserve.
- Monitor ongoing incentive compensation, restricted-stock expense, post-IPO public-company costs and the effects of increased APAM ownership on taxes and attributable earnings.