Artisan Partners Asset Management Inc. (APAM) Q2 2013 Earnings Report, Transcript and Summary

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to Artisan Partners Asset Management Second Quarter 2013 Earnings Conference Call. My name is [Mike] and I will be your conference operator today. [Operator Instructions]. At this time I will turn the call over to Ms. Makela Taphorn with Artisan Partners.

Thank you. Good afternoon everyone. Before we begin, I would like to remind you that our second quarter earnings release and the related presentation materials are available on the Investor Relations section of our website. I would also like to remind you that comments made on today’s call and some of the responses to your questions may deal with forward-looking statements and are subject to risks and uncertainties. Factors that may cause our actual results to differ from expectations are presented in the earnings release and are detailed in our filings with the SEC. And we undertake no obligations to revise these statements following the date of this conference call. In addition, some of the remarks this afternoon include references to non-GAAP financial measures. You can find reconciliations of those measures to the most comparable GAAP measures in the earnings release and exhibits which are posted on the Investor Relations section of our website. And with that I will now turn the call over to our Chief Financial Officer Eric Colson.

Thanks, Makela. Good afternoon and welcome to the Artisan Partners Asset Management business update and quarterly earnings call. I'm Eric Colson, CEO. And I'm joined today by C.J. Daley, CFO. Thank you for your time today. I hope you find this discussion useful. During this time I want to make sure to reinforce our long-term business strategy and approach through a current presentation of our operational and financial statistics. But more importantly, I want to begin a pattern of diving a little deeper into one of our primary beliefs. This quarter the deep-dive will focus on talent management. We are very committed to managing our business for passionate investors to deliver performance and results for our clients. Once I'm done, C.J. will take the lead on walking through our financials. Beginning with slide two, we have a basic set of business facts. This is the first of several slides that will hopefully become familiar to all of our call participants. Markets can fluctuate a fair amount point to point, particularly over short timeframes such as quarterly reporting periods. Our view of our business and how we measure and think about progress does not. I will make sure to highlight changes that we believe are important to discuss as I page through the presentation. Since our last reporting period, the change of note on this page are the change in assets under management and a number of investment strategies we offer. A relatively flat period for Global Equity markets. Our assets under management grew past $85 billion through a combination of organic growth and alpha generation from our investment teams. At the end of the quarter we launched our 13th investment strategy and first since 2010, Artisan Global Small Cap Growth. This strategy is managed by our Global Equity team. It…

Thanks, Eric. Good afternoon everyone. Slide 11 begins a review of our second quarter June 2013 results. In summary it was a strong quarter for our firm. It marked the first full quarter for our firm as a public company. AUM increased to $85.8 billion. Net client cash flows were $1.4 billion and translated into a 9% increase in revenue over the preceding first quarter ended March 31, 2013. Our adjusted operating margin improved meaningfully to 44.6%, but does not yet include the impact of post-IPO equity-based compensation expense. Net income per share on an adjusted basis was $0.64 per share. On July 17th our Board of Directors declared a dividend of $0.43 per Class A common share to shareholders of record on August 12. I will talk more about each of these metrics on the following pages. Moving to slide 12, [pending] assets under management was $85.8 billion, up 3% from assets of $83.2 billion at March 31, 2013 and up 34% from assets a year ago. Average assets for the second quarter were $85.3 billion, up 8% from average assets in the first quarter of this calendar year. The increase in AUM during the second quarter was due to $1.4 billion of net client cash inflows which equates to a 1.7% organic growth rate for the quarter and 7% annualized rate as well as 1.4% of market appreciation. Over 90% of the market appreciation in the first quarter was the result of our strategies in aggregate outperforming their broad-based benchmarks. For the six months ended June 30th, 2013, net client cash inflows were $3.6 billion. That's a 10% annualized organic growth rate. While second quarter net inflows were strong, as we expected, we saw a pull-back in investor activity this quarter. As we discussed previously, in our experience,…

Thanks, C.J. C.J. and I thank you for your interest today. We will communicate our business as we think about it and provide information for your insights and knowledge. We will open the call for questions now.

Thank you, sir. We will now begin the question-and-answer session. [Operator Instructions]. The first question we have comes from Bill Katz with Citigroup. Please go ahead.

Okay, thanks very much and thanks for that update on the philosophy for talent management. Very helpful. A question maybe to C.J. just to start off with, in terms of your margin discussion, when you think about the scale opportunity to offset some of the investment spend you highlighted with the restricted stock grants, what do you think about that margin improvement? Is that from second quarter levels or from third quarter levels net of sort of the initial tranche hitting?

I would say we were talking from second quarter levels. So, you know, we think there's still a couple of hundred basis-point improvement in the margin after, you know, after adding in the equity expense. So this quarter's margin at 44.6% is actually inflated because we don't have the equity expense. So if you roll back, you know, the 250 or so basis points next quarter that'd be layering in of that equity comp expense, you know, we think we can continue to grow from there.

Okay, that's my question. Okay, it's helpful. And then just -- Eric, you mentioned that you're still talking to a few people or teams if you will in terms of the pipeline. Just trying to triangulate between that and C.J.'s comments about the priorities for cash flows if you will. So when we think about the pipeline, do you have a [inaudible] process, you know, time to -- we should be thinking about, we might hear something, and maybe the potential size of the investment that might be out there?

Bill, you're speaking about pipeline of new teams?

Yes.

I think we want to leave some flexibility with cash. Some of the teams we're looking at are in different locations than we operate today. They operate different asset classes in the alternative space. I don’t think we have anything specifically set aside for any one team, but in the initial setup, if it requires us to set up an office or set up different upfront costs, we have some availability there of use of cash. And we're continuing to look at those teams. There's nothing that we want to announce today. But clearly we have some good discussions going on.

Okay. And then my final question, thanks for taking all my questions, as you think about the flow dynamics, and I'm appreciative of the seasonality of the second quarter versus Q1 for instance, when you look at some of the line items, you know, they are of lumpy nature, any sense to sort of frame out the pipeline as you look into the third quarter, whether it be RFP activity or [wins] not yet funded or any other metric you might be looking at just to help us gauge momentum into the second half of the year?

Bill, it's Eric. It looks fairly consistent. We looked at our pipeline going back a year ago to match up quarter to quarter. We looked quarter over quarter. And we see a very consistent pipeline right now of RFP activity, semifinals, finals. Our pipeline is pretty well-split between the US and non-US. So I, you know, with regards to the institutional business, you know, we believe a pretty steady rate in the pipeline -- that the pipeline's no more than 50% of our total firm given the mix of our asset base. So it's not indicative of the entire story. But we feel comfortable with the pipeline, that it should continue to keep the positive movement in cash flow.

Okay. Thanks for taking all my questions.

The next question we have comes from Robert Lee of KBW.

Hi, good afternoon everyone.

Hey, Rob.

Hey, Rob.

Hey. Maybe just to go back to the equity-based comp, I guess I just want to make sure I understand a couple of things correctly. I think, C.J., you mentioned the cost of $3.4 million, that was -- that's the annual cost or was that just the cost in the third quarter? Because I'm kind of -- given just some of the parameters you had set out, it kind of struck that that would be the annual cost of the initial grant, so I want to make sure I understand it correctly.

No, that's the next quarter's cost. And, you know, when we started going on the road, we started talking about, you know, 2% grants, you know, we're looking at stock price around $30 and our actual grant was just above $50. So as you know, the way this works, you know, we value for accounting purposes the P&L charge at the date of grant. So it was a bit larger than we originally had anticipated.

Okay. Well, we can go over some of the details offline afterwards. I guess my question would just be actually going back to the full-year payout, you know, where you'd consider a kind of fourth quarter true-up I guess I'd call it. I guess we should expect that to the extent you do one this year, it would only -- you'd only be looking at the cash generated from the second quarter on or should we really just be thinking of it in terms of the cash on the balance sheet that's in excess of $100 million could be available?

Yeah, I would say it's the latter, Rob, that we do have some excess cash on the balance sheet. The Board will consider that as part of the special dividend. But on an ongoing basis, assuming there wasn't anything above $100 million, you would think about it as sort of the cash generated for the year.

Okay, great. And just one or two more, and I appreciate your patience, I think you mentioned that the spending on the proxy solicitation, is that expected to begin in the fourth quarter, but you're going to exclude that from adjusted, is that correct?

Yeah. I think it will actually start in the third quarter and we will exclude it as a non-GAAP measure and exclude that from, you know, from adjusted earnings per adjusted share.

And that will probably continue for two or three quarters I guess, so that things can take a while?

Yeah, they can.

And lastly, and again I appreciate your indulgence here, just trying to get some sense of, you know, even though it was early on in the quarter, just, you know, any kind of early read on how the progression of new business trends, are you kind of seeing, you know, investor engagement, you know, pick up after maybe June or there hasn't really been an interruption? And I'm just trying to get a sense for your take on various investors' appetite for committing capital.

Robert, it's Eric. It's been fairly consistent from the last quarter to this quarter. I don’t think we've seen any movement either direction. So I'd say it's fairly consistent following on from last quarter.

Right. Great. Thanks for taking my questions.

The next question we have comes from Michael Kim of Sandler O'Neill.

Hey guys. Good afternoon. First, just curious to get your take on sort of funds flow trends that we've seen across the industry, particularly as it relates to the step-up in bond fund outflows and, you know, more broadly, where you sort of see that money going. Is this the catalyst that might drive a more meaningful rotation into equities? And how is that playing out as you kind of look across your funds?

Yes, that's a tough one right now. You see money departing out of the fixed income certainly in June and, you know, people talk about equity rotation that you don't see across the industry, otherwise you'd see everybody's equity flows going out in aggregate. And we're looking at those flows and I think there's maybe a timing mismatch of them department and where they're ending up. Certainly some flows are going into the alternative space. We see the flow still occurring in alternatives and there's a positive trend, and there's a positive trend towards high value-added strategies such as ours that really distinguish themselves versus the index. And, you know, so really what we can talk about is that we still see quite a bit of demand by the institutional type buyer for truly active high value-added strategies. And if you can articulate your process and your portfolio construction and different yourself from the index and peers, we've demonstrated there's still a good opportunity out in the marketplace. If an equity rotation and a flow starts coming across the industry at large, again that's just an extra wind in our back.

Okay, that's helpful. And then maybe just a follow-up on the institutional business, I know you had a sizable client termination in the first quarter, but were there any lumpy redemptions in the separate accounts channel that hit during the second quarter?

No. No large redemption there. What we did see was quite a bit of rebalancing. I think you see in the institutional marketplace clients, you know, rebalancing back to their asset allocation, back to their limits on specific managers. So we have experienced a good positive experience with the clients and the performance has been good. With that you sometimes nip those up our barriers per each client investment policy statement's limits. So we have seen some rebalancing and you probably have seen that across the industry too though for the more active oriented managers.

Okay. And then just finally, any change in thinking as it relates to kind of capacity constraints as you look across the different teams and strategies, particularly given the ongoing growth in AUM?

We have not announced any other capacity constraints with regards to, you know, the five teams of any material matter. In the Global Value we've been closed in small -- in separate accounts for Global Value which we knew going into the last quarter. We're seeing, you know, some tightening around some of our small cap growth strategy where we've seen some good flow. But there hasn't been any material impact there on our total capacity.

Okay. Thanks for taking my questions.

[Operator Instructions]. The next question we have comes from Cynthia Mayer, Bank of America-Merrill Lynch. Please go ahead.

Hi. Thanks a lot. Just in terms of the sales overseas, what products are primarily, you know, picking up and what channel is that? And then you mentioned also I think that four out of five channels were positive so I'm wondering which one was not.

Certainly, Cynthia. Overseas it's really been our global strategies. We have our Global Value, our Global Opportunities and Global Equity. The performance has been strong across all three strategies. So we've been seeing quite a bit of activity with those three strategies in Europe. And we have seen continued interest in our US Value as well in Europe. We've seen a desire to increase their North America or US exposure there. Those have been the primary strategies overseas, specifically more in the European region. We've had some, you know, small interest in Asia, but I'd say that's down the road. With regards to the channels, you know, for this quarter our defined contribution channel was slightly negative for the quarter. And the institutional broker dealer, financial advisor and retail were all in positive territory.

And why do you think the defined contribution would be negative in the second quarter?

We continue to see some challenges there of, you know, working with the target date funds and where net new dollars are going. We had a -- we still have positive flows for the year to date in defined contribution that just chalked it up for the quarter of dollars going into broader asset allocation products versus specific strategies such as ours.

Okay.

That's been a flat area for the last couple of years though, which we talked about in the road show and we talked about last quarter, is just we're still waiting for that open architecture to really hit in the defined contribution channel. You're starting to see some of that effect occur in the press recently, and we still see quite a bit of interest from consultants around target dates.

Right. Okay. And then in terms of bringing in new teams, you mentioned, you know, you're looking at teams that specialize in strategies which are viable in the institutional marketplace. So I guess how important is that to you? Is that sort of a requirement for any new team at this point?

Certainly. We want new teams to fit the institutional mindset and their asset allocation. You know, for us, we look for strategies that will have a long duration in the marketplace. And the longest duration you can go to is that institutional mindset. So we certainly don't want to find, you know, certain strategies that may be a fad or a niche today and you invest an enormous amount of time to it and then it no longer fits a client asset allocation or manager structure. So the institutional mindset is very important to us for new teams and there needs to be that fit.

Okay. And last question is just a follow up on, you mentioned that you're going to have some higher IT expenses or tech expenses 3Q and 4Q.

Yeah.

Anything special there? I don’t know, you know, how significant that is. And also, is it just sort of a step-up that will continue going --

Yeah, I would just say, it's nothing specific, it's just more the timing of projects. So, you know, across non-comp expenses, we're running a little lighter in the first two quarters than we anticipated, and we expected to pick some of that up in the second two quarters. But I'd say we're talking on a magnitude of, you know, $1 million to $1.5 million across the sort of the non-comp, yeah, the non-comp categories.

Okay, great. Thanks a lot.

The next question we have comes from Chris Shutler of William Blair.

Hey guys. Good afternoon.

Hey, Chris.

In the Global Opportunities and Global Equity strategies, obviously both still pretty small today relative to your total AUM and I certainly recognize the, in Global Equity, the PM changed earlier this year. But any sense in those two strategies given the strong performance how the pipeline is building?

Yeah, certainly, the Global Opportunities has a very robust pipeline right now, has a longer track record, and we see quite a bit of interest both the US and non-US for that strategy. The Global Equity, however, given its performance and, you know, the team's performance across all the strategies for International Equity, Non-US Small Cap and the new Global Small Cap strategy, they've all been doing quite well. So that is picking up steam. And both strategies make up quite a bit of the pipeline right now.

Okay. And then the only other question I had is just on the distribution front. Any new developments to note in the I guess the build-out of your distribution effort, new geographies, anything like that you could update us on?

No. There's no build-out, anything new. We've, you know, continue to operate quite well out of our London office. The UCITS experienced good solid growth, those across the $1 billion mark in assets in the UCITS. As I mentioned on the call they have a faster growth rate than what we're seeing here in the US. So we're very pleased with that outcome. And we haven't added any new resources around it.

Okay. Thank you.

At this time we're showing no further questions. We'll go ahead and conclude our question-and-answer session. I would now like to turn the conference back over to Mr. Eric Colson for any closing remarks. Sir?

Thank you. Well, I just want to thank everybody for their time and appreciate everybody's questions. Thank you.