Artisan Partners Asset Management Inc. (APAM) Q1 2020 Earnings Report, Transcript and Summary

Hello, and thank you for standing by. My name is Chuck, and I'll be your conference operator today. [Operator Instructions]. As a reminder, this conference is being recorded.At this time, I would now like to turn the call over to Makela Taphorn, Director of Investor Relations for Artisan Partners Asset Management. Please go ahead.

Thank you. Welcome to the Artisan Partners Asset Management Business Update and Earnings Call. Today's call will include remarks from Eric Colson, Chairman and CEO; and C.J. Daley, CFO. Our latest results and investor presentation are available on the Investor Relations section of our website. Following these remarks, we will be opening the line for questions.Before we begin, I'd like to remind you that the comments made on today's call, including responses to questions, may deal with forward-looking statements. These statements are subject to risks and uncertainties that are presented in the earnings release and detailed in our filings with the SEC. We are not required to update or revise any of these statements following the call.In addition, some of our remarks made today will include references to non-GAAP financial measures. You can find reconciliations of those measures to the most comparable GAAP measures in the earnings release.I will now turn the call over to Eric Colson.

Thank you, Makela, and thank you, everyone, for joining the call or reading the transcript. On our first quarter call, we usually go deep on the high value-added investing. On all these calls, we focus on the long term. Today, though, I will mostly talk about the last several months. Artisan Partners is designed to be a source of stability for our people, our clients and our shareholders, especially in times of uncertainty and fear. Providing stability requires that we communicate in real-time about how we are operating and our proven ability to perform through market events and across market cycles.We have been constantly communicating these points to our clients, consultants and intermediaries and with our people. We want to share the same information with our shareholders. Focusing right now on the short term does not change anything about our long-term mindset. Our goal remains for successful long-term outcomes. We will not slip into perpetual, short-term crisis mode thinking. We will remain true to who we are to the model and philosophy outlined on this page.Turning to Slide 2. Over 25 years, our business philosophy and operating model have remained consistent through time and across investment franchises. Our 9 investment teams are decentralized, autonomous, talent-driven, long-term oriented, focused on the craft of investing. We are not a factory with large offices and large teams funneling up to centralized decision makers or investment committees, producing product to feed a distribution machine. Consistent with our approach to investments, we have built an operating model that is highly flexible and highly mobile, meets the needs of 9 unique teams with 9 unique operating styles and the needs of investment in distribution professionals who travel extensively.Our operating model has contributed significantly to our ability to operate successfully during the COVID-19 crisis. Our commitment to hiring and retaining great people has also been critical. Over the last 3 months, I have been so impressed with the ability, ingenuity and dedication of each and every one of our associates.Through this recent period, we have fielded a large number of questions from clients, consultants and intermediaries. Let me take you through some of the most common and our answers. Are you operationally sound? Yes, we are operating well. Our investment teams are taking advantage of market dislocation and volatility. Our traders are executing a large volume of transactions. Our distribution and marketing professionals are communicating with clients and prospects using multiple technologies. And our business and operation teams continue to provide high-quality tailored support.Are you working from home and doing your part to socially distance and flatten the curve? Yes. Nearly all of our associates are working from home. We have supported them in whatever way necessary so they can continue to invest and perform for our clients.Any liquidate positions to meet redemption requests? Can you put money to work for clients looking to rebalance and lean in? Yes. Our traders have successfully handled large flows both in and out. During the month of March, they traded shares valued at approximately $7.6 billion, nearly 3x the dollar volume executed in March of last year.Artisan Partners is demonstrating the steadiness and consistency that are hallmarks of the firm. On this slide, the green bars show the average trailing 12-month excess returns of Artisan's strategies over the last 25 years. Over time, we have grown to 9 autonomous teams, managing 18 investment strategies in multiple asset classes for sophisticated clients around the world. As you can see, we have consistently beat benchmarks by meaningful amounts. In recent periods, with additional degrees of freedom across our business, including our high degree of freedom third-generation strategies, our alpha generation has been very strong. Our firm is designed to perform and add value through market shocks and over market cycles. We have done so, and we expect to continue to do so.Right now, not only are we getting the day-to-day job done, we are also executing longer term initiatives. In the midst of the crisis, the leaders of our marketing and communications team came to me and said that now was the time to launch Artisan Canvas, the firm-wide blog we've been developing for some time. The blog has already proven to be an ideal medium for communicating in real-time with multiple constituents across geographies.Artisan Canvas is one of many investments we have made in digital marketing. We have been methodical in our approach, doing things in a way that fits our model and culture waiting to see what works and looking for points of leverage. We have hired talented investment writers who are dedicated to investment teams so they can efficiently and effectively communicate with clients and prospects. We have a talented and long-tenured team of designers and marketing professionals who package and present our stories across multiple media.And more recently, we have hired people and added software to leverage our content, distributed effectively and learn from the data we received about who's engaging with what and how. While this is a long-term journey for us, we have accelerated and expanded our efforts in the last 2 months.In addition to launching Artisan Canvas and expanding our digital marketing, we recently reached terms on several new distribution partnerships that should provide access to new markets and clients. We believe we have identified great long-term partners, giving us leveraged opportunities to grow and diversify our business. And during a time of unprecedented activity, our IT team completed the migration of our IT operating environment to the cloud, culminating a multiyear process that will give us greater capability, flexibility, efficiency and security. I applaud Dan Greller and his entire IT team's performance. Their efforts over many years have prepared us well for recent events, and they have executed extremely well supporting our entire firm as we migrated to working from home.Our operating model is working well. As C.J. will discuss, our financial model is also working well. Most importantly, as you can see on Slide 4, we have strong long-term investment performance across our business. Our teams are established. They were led by experienced PMs, they are disciplined in their processes and they have performed.Today, after the market draw down, for the first time in many years, all of our investment strategies are open to new clients and investors. We are seeing a lot of interest as sophisticated allocators look to rebalance and put money to work with a proven and trusted investment firm. As of April 24, we have year-to-date net inflows of $1.3 billion with positive year-to-date net flows in 13 of our 18 strategies. We are seeing demand across all 3 generation of strategies. The third-generation continues to garner the most net inflows, having together raised over $2 billion of net inflows so far in 2020.Our recent flows include some sizable withdrawals from clients needing liquidity to navigate the COVID-19 crisis, including endowments and hospital operating pools. While the circumstances are painful for everyone, these withdrawals remind us that what we do is about a lot more than beating a benchmark or making money. It's about serving clients, serving people, who have saved for the future for a crisis, for a purpose and who have entrusted us to manage their savings for a period of time. Eventually, they will use their capital to do what they do to serve the people they serve. It's a great honor for us to be part of that. Our purpose as a firm is to serve these people well.As I did at the beginning of my remarks, I want to emphasize that this update on short-term flows does not reflect a change in our mindset or reporting plans. In our recent discussions with clients and prospects, it has been important to provide data points supporting the strength and stability of our firm. We want to share those data points with all constituents. We have always said that flows will be lumpy from quarter-to-quarter and year-to-year. We are not attempting to engineer flows. We value long-term relationships, and we have established many long-term trusted partnerships with sophisticated clients, consultants, allocators and intermediaries. These partners value the consistency of what we do, how we operate, how our teams invest and how we communicate.If we perform as a firm and our investment teams continue to deliver long-term, high value-added performance, we will have plenty of capital to manage. We expect the vast majority of our growth will result from compounding client assets over long time periods, not from net flows. Through our 25 years, we have remained disciplined in our philosophy and approach. We have remained focused on high value-added talent-driven investments. We have identified, recruited and partnered with unique investment leaders. With them, we have built investment franchises that generate alpha. We do this over and over again.We get stronger with time. Our existing teams gain experience, generate performance and build trust. Our operating platform becomes more capable and nimble, and we diversify our business across independent alpha sources, asset classes, geography and client type.As you can see on Slide 5, a portfolio of $1 million invested in each of our strategies at inception would have grown to $77.6 million at March 31. That's greater than 50% more wealth than had the same dollar has been invested in the indexes. That's high value-added investing.Looking ahead, we are well positioned to build on our long-term relationships, add degrees of freedom and become an even more trusted and capable adviser to our clients. Each of our existing teams has investment capacity. There's a healthy supply of external investment talent looking for a home and recent market events should drive further demand for highly differentiated, idiosyncratic, judgment-driven investment ideas and strategies, which has been our focus for 25 years.I will now turn it over to C.J. to discuss how our financial model has performed.

Thanks, Eric, and good morning, everyone. I hope you and your family and friends are safe and healthy. In a very quick time period, we have seen the world transition from relatively stable environment to one experiencing extreme uncertainty surrounding the impact of COVID-19 on our daily lives and the global economy. As Eric described in his comments, in times like these, we believe it's important to remain disciplined in our approach to running our business and to focus on what we can control.Our financial model, the components of which we have highlighted on Slide 6, was built to withstand market volatility. Many of our operating expenses vary directly with revenue, which provides predictability during periods of global market volatility, take great care in our budgeting process to appropriately balance the percentage of our expenses that are variable with those that are fixed in nature. This includes stress testing our budgets and knowing where we can pull back on expenses without sacrificing the quality of our services.Our financial model continues to act as intended, and our business is more diversified than ever. We have added talent, developed our third-generation strategies and strengthened our distribution and operational capabilities over the last several years. We now have 9 autonomous investment teams, 18 investment strategies, spanning a range of asset classes, multiple distribution channels across geographies and robust operational capabilities.Our financial results for the quarter are in line with our expectations given the significant declines in global financial markets and higher seasonal expenses, which we incur in each March quarter. AUM on Slide 7 had the quarter at $95.2 billion, down 21% compared to last quarter and down 12% compared to the March quarter of 2019, primarily reflecting the sharp decline in global markets in March. The impact of global market declines reduced AUM by 23% in the quarter, but was offset by 200 basis points or $2.8 billion of excess returns generated by our investment teams. And we had modest net client outflows of $449 million.AUM by generation is on Slide 8. During the quarter, our third-generation strategies had $1.1 billion of net client cash inflows and close to $1 billion of excess returns. Our first-generation strategies did experience net client outflows, but alpha generation more than offset those outflows. Ahead of the market downturn, our AUM reached a record high of $125 billion on February 19. And since the market lows on March 23, net client inflows have been positive for 20 of 23 days.Our key financial metrics are presented on Slide 9. As always, I will focus my comments on adjusted results which we utilize to evaluate our business and operations. Our complete GAAP and adjusted results are presented in our earnings release. Financial results for the quarter compared to the prior quarter reflect lower average AUM, one less day in the quarter and first quarter seasonal expenses, partially offset by higher performance fees. Revenues declined 3% on 2% lower average AUM and one less day in the quarter. Those declines were partially offset by $2.9 million of performance fees earned from a single global opportunities client.Operating expenses were up 2% compared to the prior quarter, primarily due to $5 million of seasonal expenses, partially offset by lower travel expense resulting from COVID-19 shelter-in-place mandates. Resulting operating income for the quarter was down 11% from the prior quarter, and our operating margin was 35%. Adjusted net income of $51.7 million and adjusted net income per adjusted share of $0.66 were each down 12% from the prior quarter.Results relative to the first quarter of 2019 reflect higher revenues on higher average AUM, one additional day in 2020 and the performance fee previously mentioned. Variable compensation and distribution expenses increased with revenues. Fixed expenses declined, primarily due to higher occupancy charges in the first quarter of 2019 related to investment team relocations. As a result, our operating margin improved to 35% from 30.9% and adjusted net income per adjusted share increased 20%.Turning to Slide 10. Our balance sheet remains healthy, and we are well positioned to absorb the recent volatility we have experienced in the markets. We maintain approximately $100 million of excess cash to fund operations, seed new products and make continued investments in new teams operational capabilities and technology. In addition, we maintain an undrawn line of credit of $100 million. Debt of $200 million is supported by ample cash flow and EBITDA. Our leverage ratio is 0.6x EBITDA and well below the limits specified in our debt covenants.As a result of the strength of our cash flow and balance sheet, we remain committed to our dividend policy of distributing approximately 80% of the cash generated by the company each quarter in the form of a variable cash dividend. Our Board of Directors declared a cash dividend of $0.61 per share with respect to the first quarter of 2020. That represents an approximate $0.10 annualized yield at recent stock price levels before considering the special annual dividend.Now more than ever, I am appreciative of our business and financial model. Despite the unprecedented disruptions to people's lives and the economy as a result of COVID-19, our model continues to operate and act as intended. Of course, AUM levels remain lower so far in Q2. This will drive a commensurate decline in revenues. In addition, we expect that travel costs will be lower in future quarters as our associates continue to abide by shelter-in-place orders. We also anticipate modestly lower technology and fixed compensation expenses as we prioritize our most impactful projects and delay hiring plans in this difficult environment for recruiting and on boarding. At this time, we do not expect any workforce reductions or meaningful impacts to our operating plans. We do not know how global markets will behave over the remainder of the year, but we are confident in our financial model and conservative balance sheet will allow us to remain focused on delivering for our clients, associates and shareholders.That concludes my comments, and we look forward to your questions. I will now turn the call back to the operator.

[Operator Instructions]. Our first question today comes from Mike Carrier from Bank of America.

So you guys mentioned the strong net flows year-to-date, which is a surprise given the backdrop. I guess as we dig into that trend, can you provide a bit more detail on the drivers since -- I look at it, you've had the strong alpha generation, you've been making ongoing investments. And so from a sales standpoint, I guess some of the investments in distribution and more the client relationships, the opening of funds or some clients rebalancing? And then if you can give us some indication on just the redemption trends as well?

Yes. Mike, thanks for calling in. It's Eric. Yes, the primary driver for the flows was rebalancing. People take an opportunity of the drawdown, the big -- a big amount of those rebalancing was, obviously, from existing clients. We did pick up some new accounts during that time period, but the driver was rebalancing.

Okay. And then in the past, there's been -- with some clients, there's been a little hesitation on when we think about the expenses for active managers and what they're willing to pay. And you guys have, I'd say, just given the alpha generation that you've had, you have been more prone to kind of sticking with where your expenses are. In this environment, are you seeing clients more willing to pay for -- not necessarily active, but for those strategies that are able to generate alpha in less pressure on the fee side?

No. Mike, I think the same conversations occurring pre and currently in the crisis that as a fiduciary, I think the responsibility is to ask about fees and expenses, and we consistently get those questions as we negotiate new relationships or even existing relationships that increase their asset size. Inevitably, there's going to be a discussion around fee and fee rates. So the questions are still coming in, and our answers have been consistent pre and during the current environment. So I don't expect those to be going away.

Our next question comes from Bill Katz from Citigroup.

I appreciate all the extra color. Just first question just centers on some of the new distribution opportunities you mentioned, Eric, in your prepared remarks. I was wondering if you might be able to dimension maybe where those are, if you are not able to give by name, I should understand that. And maybe what the incremental opportunity might be?

Yes, certainly. Over the last couple of years, we've been building out various relationships and partnerships. And the relationships are pretty widespread. I would describe a couple broaden our geographical footprint in a few parts of the world that gets us a leverage distribution opportunity, where we're providing a sub-advisory relationship and leveraging into someone else's distribution network and professionals. We are also looking at a few opportunities that we've solidified to get us deeper into the intermediary and wealth channel that's, I think, will be beneficial in the future here.Then we're also finishing up and completing some partnership relationships that broadens out our vehicles and how we deliver our strategies. So it's been fairly widespread during this last couple of months to take advantage of some relationships that we've been building. And we're happy to be completing those partnerships over the last couple of weeks and expect that we'll be able to benefit on that in the coming years.

Okay. That's helpful. And just 2 more for me. I appreciate taking the questions. You had mentioned some big wins in and out. I was wondering if you might be able to quantify some of the outs? And underneath that, where are the reallocations coming from? Is it from fixed income? Is it from passive? Is it from alternative? Just trying to get a sense of where the flows are coming from on the in as well.

Bill, it's C.J. Yes. So again, I think it's reallocations. Some of them have come as people reallocate out of international and global strategies. And they've been -- a few of them there's obviously been more on the win side, given the updates that we've given. And those have been sort of broad-based, and as Eric said, they've been rebalances from fixed into equities to take advantage of the current market environment.

Okay. Just one last one here for you, C.J. You had mentioned you finished off some IT. And just sort of wondering and gave, I guess, some soft guidance around the outlook on some of the G&A lines. Is there something more structural afoot here that might give you a lot more operating leverage going forward than otherwise would have in case -- given the case given sort of the push toward digital? And then are you finding some new workarounds here that could otherwise reduce the slope of growth on expenses, just given that we're all sort of operating under new sort of virtual backdrop?

Yes. Yes. No, that's a good question. I mean the structural move has really been happening over several years as we've automated, improved systems. And you've seen efficiencies increase as we're able to process more with fewer head count additions. And then I think on the second part of the question, it's a little too early to tell. Our model is pretty lean to begin with and how actually people will adjust their work environment coming out of this remains to be seen. I don't think it will be anything material to our cost structure, as you know, because most of our cost structure is variable compensation, which obviously won't change. So I think it will be on the margins, if there is anything, but we certainly will be looking at that as we emerge out of this.

Our next question comes from Robert Lee from KBW.

I guess I was wondering, you had a -- gross sales were up pretty nicely in the funds business and separate accounts too as well. But was there any of these new or recently added distribution relationships that are helping to drive the healthy increase in gross sales that you saw on the retail side and the mutual fund side?

Rob, it's Eric. The comments I made in the prepared remarks around new distribution partners where contracts and relationships we're solidifying now, they weren't driving the current year-to-date gross flows.

I mean was there anything that maybe you added over the past year or 2 that how you're starting to see that pay off? Or that was really pretty much just legacy relationships?

I'll say it was a mix. We did pick up a few good new institutional relationships during this time period, but it was driven by people or consultants that we've known for years that have already done the research and the due diligence. And so it was a mix of some new and a healthy amount of existing relationships that are just putting more money to work with us.

Okay. Great. And just maybe one other quick one. To the extent, kind of looking ahead with -- in addition to the new distribution relationships, I think mainly on the institutional side. Can you talk a little bit about kind of new client activity? I'm assuming that you think it would maybe be slow up to some degree, but given the environment, it's tougher to due diligence. Are you seeing that? Or do you expect kind of new clients -- new institutional clients that activity should just remain healthy or pick up? Kind of any color around that.

Yes. Just to provide some color around our distribution and relationship building, during the crisis, obviously, everybody in a shelter-in-place and working from home, myself as well as our distribution team, all stated that our relationships got deeper with existing clients and consultants as we all shared stories about our lives and either called or had a Zoom call into each other's homes and those relationships got deeper and stronger. We also have been surprised that the increase in new relationships as well. And we weren't expecting as many new relationships that came in or the ability to broaden out, but there were clearly -- and some of the newer strategies, our ability to add new relationships.And I think the primary driver was a commitment and effort into the institutional channel as well as some intermediary groups that had research teams that we've built relationships over the years that they had the confidence in Artisan Partners' operations and the relationships we've built that has allowed us to extend into some newer relationships. So looking ahead, well, I wouldn't have said that a couple of weeks ago. Today, we continue to still build new relationships and push forward.

Our next question comes from Alex Blostein from Goldman Sachs.

I wanted to get your thoughts on the dynamics in the 401(k) channel. I guess one, to what extent DCIO and 401(k) assets still comprise a portion of Artisan's AUM. So maybe you can help size that and thinking about some of the implications, both with respect to unemployment and relief for withdrawals with new penalty through the end of the year. How meaningful of an impact do you think that could be on the flows?

Yes. Certainly, Alex, as we've mentioned on past calls that quite a bit of our outflows over the last couple of years have come out of our 2 mid-cap strategies that were primarily in quite a bit of 401(k) and DC opportunities. Those assets have gone down over the years. We've replaced those with a healthy amount of institutional assets outside the U.S. So it's brought down our overall DC assets to approximately 12%. A good chunk of those are with separate accounts, and there's still a good amount that are in our mutual funds as well.Given the smaller exposure, the relationships that we've established in the separate account space for DC, I don't feel like we'll be impacted to the same degree as the larger target date funds where the bulk of the assets have all gone to over the last 5, 6, 7 years. So I feel like our exposure is low and with a healthy relationship that have extended for years in that space.

Our next question comes from Chris Shutler from William Blair.

Eric, can you talk about your discussions with, I guess, new investment talent? And is it your expectation that you could emerge from this crisis with maybe a little bit of an increased pace of hiring?

Sure. The new team discussions continue. I'd say, it would be very similar to my comments around distribution. When you meet person for the first time and start exploring new opportunities, the relationship jumps quickly into a personal relationship because you're zooming right into each other's lives. So the opportunities are still out there. The means of interacting and get to knowing each other are different, but I think, healthy.And I think the pipeline will continue. The rate at which Artisan converts, obviously, is fairly slow. We have extremely high bar. We take our time and we're quite patient on bringing in new teams or individuals. So I don't think see any disruption on the pipeline of talent, and I don't see an extraordinary uptick either. We are thinking about where asset allocation is going to go and how the stimulus and the economy will change people's views on a go-forward basis on asset allocation and how much inflation will play in, how much should we be looking at real assets, infrastructure, real estate to thinking about more tax-efficient strategies.So primarily, we're using the opportunity to process the impact and think about the long-term effects and how we should be thinking about new teams on a go-forward basis. So we're spending more time there than we are picking up calls specifically just to meet with people.

Our next question comes from Kenneth Lee from RBC.

Just at a broader level. Given the firm's solid track record and what you mentioned in the prepared remarks, potentially for client preferences for differentiated investment strategies, especially during times of market volatility, wondering if you could just share with us which particular strategies that you're finding are especially resonating with clients in the current environment?

Yes. Fortunately, we also mentioned in the prepared remarks, the breadth of opportunities. We're definitely seeing the continued trend in our third-generation strategies. But as we also mentioned, we've seen quite a bit of activity in the first and second generation as well. So the activity is broad based, and we've also reopened all of our strategies. So there hasn't been one channel, one client type or one specific strategy that's driving it. And also in C.J's. prepared remarks, we've talked about the frequency as well that over the last 20-plus days, it's been fairly consistent as well. So we're happy with the consistency. We're happy about the breadth and across the various teams.

Very helpful. And just one follow-up, if I can. Any updates on new investment strategies that could be potentially introduced in over the near term?

No. We have no announcement to make any new teams. We're in a healthy dialogue with a few teams that we're always keeping in contact with groups that we would be interested in. We're picking up some new relationships and opportunities of teams. And as I said earlier, we're thinking about what categories and asset classes we're contemplating for the future, but nothing here in the short term to announce.

And our next question comes from Dan Fannon from Jefferies.

Just kind of a follow-up on some of the previous responses. You guys highlighted rebalancing as a dynamic that's been happening, but as market have continued to grind higher. I guess do you still see that playing out as kind of a driver of activity or obviously, the success you've been seeing, as you highlighted, is broad-based and across a multitude of channels and funds? So is it just -- is it more kind of your performance and kind of the basics? Or is there still some client behavior that's happening as a result of the market disruption over the last 6, 8 weeks?

I think the rebalancing will continue. And as C.J. mentioned, the broad-based rebalancing of equity and fixed, but then even in subcategories, when you look at the opportunity in the high-yield space, you look at the opportunity and value-based strategies, you feel still see the spread of return beyond the equity in fixed and beyond just the indexes. If you move past the market cap weighted index and look at the equal weighted index and the breadth, we all can see that there's been a handful of securities driving the market. And so there's still quite a bit of opportunity in rebalancing in subcategories, and we're still having some broad-based discussions of underneath the major asset classes and how to take advantage into certain specific strategies.

[Operator Instructions]. And at this time, I'm showing no additional questions. I'd like to turn the conference call back over to management for any closing remarks.

I think we're all good. Thank you for attending the call today, and everybody be safe. Thank you.

Ladies and gentlemen, with that, we'll end today's conference call. We do thank you for joining today's presentation. You may now disconnect your lines.