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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 

Form 10-Q

(Mark One)
 
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2018
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
FOR THE TRANSITION PERIOD FROM TO

Commission file number: 001-35826
 
Artisan Partners Asset Management Inc.
(Exact name of registrant as specified in its charter)

Delaware
45-0969585
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
 
 
875 E. Wisconsin Avenue, Suite 800
Milwaukee, WI
53202
(Address of principal executive offices)
(Zip Code)
 
 

(414) 390-6100
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ
 
 
Accelerated filer o
Non-accelerated filer o
 
Smaller reporting company o
 
 
 
Emerging growth company o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

The number of outstanding shares of the registrant’s Class A common stock, par value $0.01 per share, Class B common stock, par value $0.01 per share, and Class C common stock, par value $0.01 per share, as of October 26, 2018 were 54,019,493, 8,695,249 and 14,228,130, respectively.
 


Table of Contents

TABLE OF CONTENTS
 
 
Page
Part I
Financial Information
 
Item 1.
Unaudited Consolidated Financial Statements
 
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
Part II
Other Information
 
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
 
Except where the context requires otherwise, in this report, references to the “Company”, “Artisan”, “we”, “us” or “our” refer to Artisan Partners Asset Management Inc. (“APAM”) and its direct and indirect subsidiaries, including Artisan Partners Holdings LP (“Artisan Partners Holdings” or “Holdings”). On March 12, 2013, APAM closed its initial public offering and related corporate reorganization. Prior to that date, APAM was a subsidiary of Artisan Partners Holdings.
Forward-Looking Statements
This report contains, and from time to time our management may make, forward-looking statements within the meaning of the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Statements regarding future events and our future performance, as well as management’s current expectations, beliefs, plans, estimates, or projections relating to the future, are forward-looking statements within the meaning of these laws. In some cases, you can identify these statements by forward-looking words such as “may”, “might”, “will”, “should”, “expects”, “intends”, “plans”, “anticipates”, “believes”, “estimates”, “predicts”, “potential” or “continue”, the negative of these terms and other comparable terminology. These forward-looking statements are only predictions based on current expectations and projections about future events. Forward-looking statements are subject to a number of risks and uncertainties, and there are important factors that could cause actual results, level of activity, performance, actions or achievements to differ materially from the results, level of activity, performance, actions or achievements expressed or implied by the forward-looking statements. These factors include: the loss of key investment professionals or senior management, adverse market or economic conditions, poor performance of our investment strategies, change in the legislative and regulatory environment in which we operate, operational or technical errors or other damage to our reputation and other factors disclosed in the Company’s filings with the Securities and Exchange Commission, including those factors listed under the caption entitled “Risk Factors” in Item 1A of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2017, filed with the SEC on February 21, 2018, which is accessible on the SEC’s website at www.sec.gov. We undertake no obligation to publicly update any forward-looking statements in order to reflect events or circumstances that may arise after the date of this report, except as required by law.

i

Table of Contents

Forward-looking statements include, but are not limited to, statements about:
our anticipated future results of operations;
our potential operating performance and efficiency;
our expectations with respect to future levels of assets under management, including the capacity of our strategies and client cash inflows and outflows;
our expectations with respect to industry trends and how those trends may impact our business;
our financing plans, cash needs and liquidity position;
our intention to pay dividends and our expectations about the amount of those dividends;
our expected levels of compensation of our employees, including equity compensation;
our expectations with respect to future expenses and the level of future expenses;
our expected tax rate, and our expectations with respect to deferred tax assets; and
our estimates of future amounts payable pursuant to our tax receivable agreements.

ii

Table of Contents

Part I — Financial Information
Item 1. Unaudited Consolidated Financial Statements
ARTISAN PARTNERS ASSET MANAGEMENT INC.
Unaudited Condensed Consolidated Statements of Financial Condition
(U.S. dollars in thousands, except per share amount)
 
September 30,
2018
 
December 31,
2017
ASSETS
Cash and cash equivalents
$
211,431

 
$
137,286

Accounts receivable
76,820

 
76,693

Investment securities
18,204

 
4,978

Property and equipment, net
25,562

 
21,025

Deferred tax assets
433,975

 
429,212

Restricted cash
629

 
629

Prepaid expenses and other assets
13,330

 
13,364

Assets of consolidated investment products
 
 
 
Cash and cash equivalents
15,543

 
21,881

Accounts receivable and other
15,760

 
16,768

Investment assets, at fair value
65,048

 
115,319

Total assets
$
876,302

 
$
837,155

 
 
 
 
LIABILITIES, REDEEMABLE NONCONTROLLING INTERESTS, AND STOCKHOLDERS’ EQUITY
Accounts payable, accrued expenses, and other
$
23,381

 
$
23,019

Accrued incentive compensation
82,456

 
2,911

Borrowings
199,255

 
199,129

Amounts payable under tax receivable agreements
368,986

 
385,413

Liabilities of consolidated investment products
 
 
 
Accounts payable, accrued expenses, and other
12,970

 
8,180

Investment liabilities, at fair value
21,685

 
47,857

Total liabilities
708,733

 
666,509

Commitments and contingencies

 


Redeemable noncontrolling interests
30,681

 
62,581

Common stock
 
 
 
Class A common stock ($0.01 par value per share, 500,000,000 shares authorized, 54,019,493 and 50,463,126 shares outstanding at September 30, 2018 and December 31, 2017, respectively)
540

 
505

Class B common stock ($0.01 par value per share, 200,000,000 shares authorized, 8,695,249 and 11,922,192 shares outstanding at September 30, 2018 and December 31, 2017, respectively)
87

 
119

Class C common stock ($0.01 par value per share, 400,000,000 shares authorized, 14,228,130 and 13,184,527 shares outstanding at September 30, 2018 and December 31, 2017, respectively)
142

 
132

Additional paid-in capital
90,609

 
147,910

Retained earnings (deficit)
38,678

 
(37,870
)
Accumulated other comprehensive income (loss)
(1,624
)
 
(873
)
Total Artisan Partners Asset Management Inc. stockholders’ equity
128,432

 
109,923

Noncontrolling interest - Artisan Partners Holdings
8,456

 
(1,858
)
Total stockholders’ equity
136,888

 
108,065

Total liabilities, redeemable noncontrolling interests, and stockholders’ equity
$
876,302

 
$
837,155

The accompanying notes are an integral part of the consolidated financial statements.

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Table of Contents

ARTISAN PARTNERS ASSET MANAGEMENT INC.
Unaudited Consolidated Statements of Operations
(U.S. dollars in thousands, except per share amounts)
 
 For the Three Months Ended September 30,

 For the Nine Months Ended September 30,
 
2018

2017

2018

2017
Revenues
 
 
 
 
 
 
 
Management fees
$
212,738

 
$
204,540

 
$
634,733

 
$
584,565

Performance fees
50

 
16

 
2,359

 
338

Total revenues
$
212,788

 
$
204,556

 
$
637,092

 
$
584,903

Operating Expenses
 
 
 
 
 
 
 
Compensation and benefits
 
 
 
 
 
 
 
Salaries, incentive compensation and benefits
102,741

 
98,525

 
314,709

 
288,200

Pre-offering related compensation - share-based awards

 

 

 
12,678

Total compensation and benefits
102,741

 
98,525

 
314,709

 
300,878

Distribution, servicing and marketing
6,566

 
7,603

 
20,422

 
22,269

Occupancy
5,337

 
3,579

 
13,564

 
10,745

Communication and technology
9,556

 
8,180

 
27,182

 
25,204

General and administrative
6,751

 
6,039

 
20,515

 
20,642

Total operating expenses
130,951

 
123,926

 
396,392

 
379,738

Total operating income
81,837

 
80,630

 
240,700

 
205,165

Non-operating income (expense)
 
 
 
 
 
 
 
Interest expense
(2,823
)
 
(2,870
)
 
(8,445
)
 
(8,671
)
Net investment gain (loss) of consolidated investment products
238

 
1,549

 
9,464

 
1,567

Net investment income
1,386

 
178

 
2,500

 
504

Net gain (loss) on the tax receivable agreements
251

 
501

 
251

 
501

Total non-operating income (expense)
(948
)
 
(642
)
 
3,770

 
(6,099
)
Income before income taxes
80,889

 
79,988

 
244,470

 
199,066

Provision for income taxes
14,172

 
21,479

 
38,444

 
49,169

Net income before noncontrolling interests
66,717

 
58,509

 
206,026

 
149,897

Less: Net income attributable to noncontrolling interests - Artisan Partners Holdings
24,021

 
27,234

 
73,380

 
72,191

Less: Net income attributable to noncontrolling interests - consolidated investment products
178

 
610

 
6,848

 
614

Net income attributable to Artisan Partners Asset Management Inc.
$
42,518

 
$
30,665

 
$
125,798

 
$
77,092

 
 
 
 
 
 
 
 
Basic and diluted earnings per share
$
0.77

 
$
0.61

 
$
2.27

 
$
1.48

Basic and diluted weighted average number of common shares outstanding
49,399,553

 
45,890,291

 
48,607,837

 
44,068,172

Dividends declared per Class A common share
$
0.60

 
$
0.60

 
$
2.59

 
$
2.16


The accompanying notes are an integral part of the consolidated financial statements.

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ARTISAN PARTNERS ASSET MANAGEMENT INC.
Unaudited Consolidated Statements of Comprehensive Income
(U.S. dollars in thousands)
 
 For the Three Months Ended September 30,
 
 For the Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Net income before noncontrolling interests
$
66,717

 
$
58,509

 
$
206,026

 
$
149,897

Other comprehensive income (loss), net of tax
 
 
 
 
 
 
 
Unrealized gain (loss) on investment securities:
 
 
 
 
 
 
 
Unrealized gain (loss) on investment securities, net of tax of $0, $113, $0, and $144, respectively

 
345

 

 
521

Less: reclassification adjustment for gain (loss) included in net income

 

 

 
93

Net unrealized gain (loss) on investment securities

 
345

 

 
428

Foreign currency translation gain (loss)
(208
)
 
422

 
(618
)
 
1,151

Total other comprehensive income (loss)
(208
)
 
767

 
(618
)
 
1,579

Comprehensive income
66,509

 
59,276

 
205,408

 
151,476

Comprehensive income attributable to noncontrolling interests - Artisan Partners Holdings
23,961

 
27,540

 
73,254

 
73,046

Comprehensive income attributable to noncontrolling interests - consolidated investment products
178

 
610

 
6,848

 
614

Comprehensive income attributable to Artisan Partners Asset Management Inc.
$
42,370

 
$
31,126

 
$
125,306

 
$
77,816


The accompanying notes are an integral part of the consolidated financial statements.

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Table of Contents

ARTISAN PARTNERS ASSET MANAGEMENT INC.
Unaudited Consolidated Statements of Changes in StockholdersEquity
(U.S. dollars in thousands)
 
Class A Common stock
Class B Common stock
Class C Common stock
Additional paid-in capital
Retained earnings
Accumulated other comprehensive income (loss)
Non-controlling interest - Artisan Partners Holdings
Total stockholders’ equity
Redeemable non-controlling interest
Balance at January 1, 2018
$
505

$
119

$
132

$
147,910

$
(37,870
)
$
(873
)
$
(1,858
)
$
108,065

$
62,581

Net income




125,798


73,380

199,178

6,848

Other comprehensive income - foreign currency translation





(447
)
(171
)
(618
)

Other comprehensive income - available for sale investments, net of tax




358

(260
)

98


Cumulative impact of changes in ownership of Artisan Partners Holdings LP, net of tax



(3,758
)

(44
)
3,802



Amortization of equity-based compensation



29,701



12,625

42,326


Deferred tax assets, net of amounts payable under tax receivable agreements



4,199




4,199


Issuance of Class A common stock, net of issuance costs
6



21,284




21,290


Forfeitures and employee/partner terminations
5

(20
)
15







Issuance of restricted stock awards
15



(15
)





Employee net share settlement
(2
)


(1,742
)


(820
)
(2,564
)

Exchange of subsidiary equity
11

(6
)
(5
)






Purchase of equity and subsidiary equity

(6
)

(21,472
)



(21,478
)

Capital contributions, net








40,883

Impact of deconsolidation of CIPs








(79,631
)
Distributions






(78,418
)
(78,418
)

Dividends



(85,498
)
(49,608
)

(84
)
(135,190
)

Balance at September 30, 2018
$
540

$
87

$
142

$
90,609

$
38,678

$
(1,624
)
$
8,456

$
136,888

$
30,681


 
Class A Common stock
Class B Common stock
Class C Common stock
Additional paid-in capital
Retained earnings
Accumulated other comprehensive income (loss)
Non-controlling interest - Artisan Partners Holdings
Total stockholders’ equity
Redeemable non-controlling interest
Balance at January 1, 2017
$
421

$
151

$
171

$
119,221

$
13,395

$
(1,648
)
$
(13,997
)
$
117,714


Net income




77,092


72,191

149,283

614

Other comprehensive income - foreign currency translation





746

405

1,151


Other comprehensive income - available for sale investments, net of tax





240

192

432


Cumulative impact of changes in ownership of Artisan Partners Holdings LP, net of tax



(5,624
)

(261
)
5,881

(4
)

Amortization of equity-based compensation



31,758



18,512

50,270


Deferred tax assets, net of amounts payable under tax receivable agreements



22,467




22,467


Issuance of Class A common stock, net of issuance costs
56



161,986




162,042


Forfeitures and employee/partner terminations









Issuance of restricted stock awards
13



(13
)





Employee net share settlement



(891
)


(586
)
(1,477
)

Exchange of subsidiary equity
10

(7
)
(3
)






Purchase of equity and subsidiary equity

(21
)
(35
)
(162,438
)



(162,494
)

Capital Contributions, net








14,655

Distributions






(81,869
)
(81,869
)

Dividends



(30,053
)
(70,587
)

(83
)
(100,723
)

Balance at September 30, 2017
$
500

$
123

$
133

$
136,413

$
19,900

$
(923
)
$
646

$
156,792

$
15,269

The accompanying notes are an integral part of the consolidated financial statements.

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Table of Contents

ARTISAN PARTNERS ASSET MANAGEMENT INC.
Unaudited Consolidated Statements of Cash Flows
(U.S. dollars in thousands)
 
 For the Nine Months Ended September 30,
 
2018
 
2017
Cash flows from operating activities
 
 
 
Net income before noncontrolling interests
$
206,026

 
$
149,897

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
4,257

 
3,859

Deferred income taxes
19,468

 
29,585

Unrealized net investment income
(1,592
)
 
(93
)
Net (gain) loss on the tax receivable agreements
(251
)
 
(501
)
Loss on disposal of property and equipment
11

 
20

Amortization of debt issuance costs
343

 
336

Share-based compensation
42,326

 
50,270

Net investment (gain) loss of consolidated investment products
(9,464
)
 
(1,567
)
Purchase of investments by consolidated investment products
(602,736
)
 
(51,546
)
Proceeds from sale of investments by consolidated investment products
579,599

 
28,596

Change in assets and liabilities resulting in an increase (decrease) in cash:
 
 
 
Accounts receivable
(126
)
 
(13,934
)
Prepaid expenses and other assets
(883
)
 
1,127

Accounts payable and accrued expenses
78,506

 
63,959

Class B liability awards

 
(506
)
Deferred lease obligations
1,522

 
1,731

Net change in operating assets and liabilities of consolidated investment products
11,241

 
7,509

Net cash provided by operating activities
328,247

 
268,742

Cash flows from investing activities
 
 
 
Acquisition of property and equipment
(1,598
)
 
(1,312
)
Leasehold improvements
(7,267
)
 
(3,037
)
Proceeds from sale of investment securities

 
6,382

Purchase of investment securities
(250
)
 
(5,250
)
Net cash used in investing activities
(9,115
)
 
(3,217
)

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ARTISAN PARTNERS ASSET MANAGEMENT INC.
Unaudited Consolidated Statements of Cash Flows, continued
(U.S. dollars in thousands)
 
 For the Nine Months Ended September 30,
 
2018
 
2017
Cash flows from financing activities
 
 
 
Partnership distributions
(78,418
)
 
(81,869
)
Dividends paid
(135,190
)
 
(100,723
)
Payment of debt issuance costs

 
(611
)
Proceeds from issuance of notes payable

 
60,000

Principal payments on notes payable

 
(60,000
)
Payment under the tax receivable agreements
(36,111
)
 
(30,234
)
Net proceeds from issuance of common stock
21,478

 
162,494

Payment of costs directly associated with the issuance of Class A common stock
(166
)
 
(294
)
Purchase of equity and subsidiary equity
(21,478
)
 
(162,494
)
Taxes paid related to employee net share settlement
(2,564
)
 
(1,477
)
Capital contributions to consolidated investment products, net
40,883

 
14,655

Net cash used in financing activities
(211,566
)
 
(200,553
)
Net increase (decrease) in cash and cash equivalents
107,566

 
64,972

Net cash impact of deconsolidation of CIPs
(39,759
)
 

Cash, cash equivalents and restricted cash
 
 
 
Beginning of period
159,796

 
157,406

End of period
$
227,603

 
$
222,378

 
 
 
 
Cash, cash equivalents and restricted cash as of the end of the period
 
 
 
Cash and cash equivalents
$
211,431

 
$
202,636

Restricted cash
629

 
629

Cash and cash equivalents of consolidated investment products
15,543

 
19,113

Cash, cash equivalents and restricted cash
$
227,603

 
$
222,378

 
 
 
 
Supplementary information
 
 


Noncash activity:
 
 
 
Establishment of deferred tax assets
$
24,123

 
$
133,544

Establishment of amounts payable under tax receivable agreements
19,683

 
111,077


The accompanying notes are an integral part of the consolidated financial statements.

6

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ARTISAN PARTNERS ASSET MANAGEMENT INC.
Notes to Unaudited Consolidated Financial Statements
(U.S. currencies in thousands, except per share or per unit amounts and as otherwise indicated)
Note 1. Nature of Business and Organization
Nature of Business
Artisan Partners Asset Management Inc. (“APAM”), through its subsidiaries, is an investment management firm focused on providing high-value added, active investment strategies to sophisticated clients globally. APAM and its subsidiaries are hereafter referred to collectively as “Artisan” or the “Company”.
Artisan’s autonomous investment teams manage a broad range of U.S., non-U.S. and global investment strategies that are diversified by asset class, market cap and investment style. Strategies are offered through multiple investment vehicles to accommodate a broad range of client mandates. Artisan offers its investment management services primarily to institutions and through intermediaries that operate with institutional-like decision-making processes and have long-term investment horizons.
Organization
On March 12, 2013, APAM completed its initial public offering (the “IPO”). APAM was formed for the purpose of becoming the general partner of Artisan Partners Holdings LP (“Artisan Partners Holdings” or “Holdings”) in connection with the IPO. Holdings is a holding company for the investment management business conducted under the name “Artisan Partners”. The reorganization (“IPO Reorganization”) established the necessary corporate structure to complete the IPO while at the same time preserving the ability of the firm to conduct operations through Holdings and its subsidiaries.
As the sole general partner, APAM controls the business and affairs of Holdings. As a result, APAM consolidates Holdings’ financial statements and records a noncontrolling interest for the equity interests in Holdings held by the limited partners of Holdings. At September 30, 2018, APAM held approximately 70% of the equity ownership interest in Holdings.
Holdings, together with its wholly owned subsidiary, Artisan Investments GP LLC (“AIGP”), controls a 100% interest in Artisan Partners Limited Partnership (“APLP”), a multi-product investment management firm that is the principal operating subsidiary of Artisan Partners Holdings. APLP is registered as an investment adviser with the U.S. Securities and Exchange Commission under the Investment Advisers Act of 1940. APLP provides investment advisory services to separate accounts, including privately offered funds, and pooled investment vehicles, including Artisan Partners Funds, Inc. (“Artisan Funds”) and Artisan Partners Global Funds plc (“Artisan Global Funds”). Artisan Funds are a series of open-end, diversified mutual funds registered under the Investment Company Act of 1940, as amended. Artisan Global Funds is a family of Ireland-domiciled UCITS.
2018 Follow-On Offering
On February 27, 2018, APAM completed a registered offering of 644,424 shares of Class A common stock (the “2018 Follow-On Offering”) and utilized all of the proceeds to purchase an aggregate of 644,424 common units of Artisan Partners Holdings at a price per unit of $33.33. The offering and subsequent purchase of units had the following impact on the consolidated financial statements:
APAM received 644,424 GP units of Holdings, which increased APAM’s ownership interest in Holdings. See Note 7, “Noncontrolling interest - Holdings” for the financial statement impact of changes in ownership.
APAM’s purchase of common units of Holdings with the proceeds resulted in an increase to deferred tax assets and amounts payable under the tax receivable agreements. See Note 11, “Income Taxes and Related Payments”.
Holdings Unit Exchanges
Limited partners of Artisan Partners Holdings are entitled to exchange partnership units (along with a corresponding number of shares of Class B or C common stock of APAM) for shares of Class A common stock from time to time (the “Holdings Common Unit Exchanges”). The following partnership units were exchanged for APAM Class A common stock during the nine months ended September 30, 2018:
 
Total Common Units Exchanged
Class A Common Units
Class B Common Units
Class E Common Units
Common units exchanged on March 1, 2018
958,288

499,222

449,066

10,000

Common units exchanged on April 2, 2018
452,628



452,628

Common units exchanged on May 9, 2018
62,000


57,000

5,000

Common units exchanged on August 8, 2018
66,000


50,000

16,000

Total Units Exchanged
1,538,916

499,222

556,066

483,628



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The corresponding shares of APAM Class B and Class C common stock were immediately canceled upon exchange. The Holdings Common Unit Exchanges increased APAM’s equity ownership interest in Holdings and resulted in an increase to deferred tax assets and amounts payable under the tax receivable agreements. See Note 11, “Income Taxes and Related Payments”.
Note 2. Summary of Significant Accounting Policies
Basis of presentation
The accompanying financial statements are unaudited. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of such consolidated financial statements have been included. Such interim results are not necessarily indicative of full year results.
The consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial reporting and accordingly they do not include all of the information and footnotes required in the annual consolidated financial statements and accompanying footnotes.
The year-end condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by U.S. GAAP. As a result, the interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in APAM’s latest annual report on Form 10-K.
The accompanying financial statements were prepared in accordance with U.S. GAAP and related rules and regulations of the SEC. The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates or assumptions that affect the reported amounts and disclosures in the financial statements. Actual results could differ from these estimates or assumptions.
Principles of consolidation
Artisan’s policy is to consolidate all subsidiaries or other entities in which it has a controlling financial interest. The consolidation guidance requires an analysis to determine if an entity should be evaluated for consolidation using the voting interest entity (“VOE”) model or the variable interest entity (“VIE”) model. Under the VOE model, controlling financial interest is generally defined as a majority ownership of voting interests. Under the VIE model, controlling financial interest is defined as (i) the power to direct activities that most significantly impact the economic performance of the entity and (ii) the right to receive potentially significant benefits or the obligation to absorb potentially significant losses. Artisan generally consolidates VIEs in which it meets the power criteria and holds an equity ownership interest of greater than 10%. The consolidated financial statements include the accounts of APAM and all subsidiaries or other entities in which APAM has a direct or indirect controlling financial interest. All material intercompany balances have been eliminated in consolidation.
Artisan serves as the investment adviser to Artisan Funds, Artisan Global Funds and other investment products, including Artisan sponsored private funds. Artisan Funds and Artisan Global Funds are corporate entities the business and affairs of which are managed by their respective boards of directors. The shareholders of the funds retain voting rights, including rights to elect and reelect members of their respective boards of directors. Each series of Artisan Funds is a VOE and is separately evaluated for consolidation under the VOE model. The shareholders of Artisan Global Funds lack simple majority liquidation rights, and as a result, each sub-fund of Artisan Global Funds is evaluated for consolidation under the VIE model. Artisan sponsored privately offered funds are also evaluated for consolidation under the VIE model because third-party equity holders of the funds generally lack the ability to divest Artisan of its control of the funds.
From time to time, the Company makes investments in Artisan Funds, Artisan Global Funds, and Artisan sponsored private funds. If the investment results in a controlling financial interest, APAM consolidates the fund, and the underlying activity of the entire fund is included in Artisan’s Consolidated Financial Statements. As of September 30, 2018, Artisan has a controlling financial interest in three sub-funds of Artisan Global Funds and certain privately offered funds and, as a result, these funds are included in Artisan’s Consolidated Financial Statements. Because these consolidated investment products meet the definition of investment companies under U.S. GAAP, Artisan has retained the specialized industry accounting principles for investment companies in its Consolidated Financial Statements. See Note 6, “Variable Interest Entities and Consolidated Investment Products” for additional details.

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Table of Contents

Recent accounting pronouncements
Accounting standards adopted as of January 1, 2018
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, which supersedes existing accounting standards for revenue recognition and creates a single framework. The guidance also changes the accounting for certain costs to obtain or fulfill a contract. The Company adopted ASU 2014-09 as of January 1, 2018, utilizing the modified retrospective method. There was no cumulative effect adjustment of applying the new revenue standard and the comparative information has not been restated. There are no significant differences between the reported results under the revenue standard and what would have been reported under the previous revenue guidance, other than the disclosures included in Note 9, ”Revenue From Contracts with Customers”.
The application of ASU 2014-09 had no impact on the Consolidated Statement of Financial Condition as of September 30, 2018, as compared to the previous revenue recognition standard. The application of the new principal versus agent guidance resulted in presentation changes whereby certain costs are now reported on a gross basis, when the Company is acting as principal, and reported on a net basis, when the Company is acting as an agent. The new standard requires the entire amount of fee waivers and expense reimbursements to be presented net against revenue, which resulted in a $16 thousand decrease in management fee revenue and a corresponding $16 thousand decrease in general and administrative expenses within the Consolidated Statements of Operations for the nine months ended September 30, 2018. Applying ASU 2014-09 had no impact on operating income or net income, as compared to applying the previous revenue recognition standard. Artisan did not apply any of the practical expedients in ASU 2014-09.
In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities, which requires all equity investments to be measured at fair value with changes in the fair value recognized through net income. The Company adopted ASU 2016-01 as of January 1, 2018, utilizing the modified retrospective method. Upon adoption, the Company made a cumulative-effect adjustment to the Company’s Consolidated Statements of Financial Condition, which resulted in a $0.4 million decrease to accumulated other comprehensive income (loss) and a corresponding $0.4 million increase to retained earnings (deficit). The application of ASU 2016-01 results in the recognition of the Company’s unrealized gains (losses) on investment securities through net income. The Company recognized $1.6 million of unrealized gains in net income for the nine months ended September 30, 2018.
In November 2016, the FASB issued ASU 2016-18, Restricted Cash, to clarify guidance on the classification and presentation of restricted cash in the statement of cash flows. Restricted cash and restricted cash equivalents, including cash of consolidated investment products, is required to be included in cash and cash-equivalent balances in the statement of cash flows. The guidance is effective as of January 1, 2018, and requires retrospective application to all periods presented. The Consolidated Statements of Cash Flows includes a reconciliation to the line items on the Consolidated Statements of Financial Condition.
Accounting standards not yet adopted
In February 2016, the FASB issued ASU 2016-02, Leases, which introduces a lessee model that brings most leases on the balance sheet. In July 2018, the FASB issued ASU 2018-11, Leases - Targeted Improvements, which provides an optional transition method related to implementing the new lease standard. Under this new transition method, an entity initially applies the new leases standard at the adoption date and recognizes a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. The Company plans to adopt the new standard on January 1, 2019, using the optional transition method. The Company is currently evaluating the impact of adoption on its Consolidated Financial Statements. The standard is expected to result in a significant increase in total assets and total liabilities, but will not have a significant impact on the Consolidated Statements of Operations.
In August 2018, the FASB issued ASU 2018-15, Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract, which aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The capitalized implementation costs will be expensed over the term of the hosting arrangement. The Company currently expenses implementation costs in hosting arrangement as the costs are incurred. The new guidance will be effective on January 1, 2020. The Company is currently evaluating the impact of adoption on its consolidated financial statements.

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Table of Contents

Note 3. Investment Securities
The disclosures below include details of Artisan’s investments, excluding money market funds and consolidated investment products. Investments held by consolidated investment products are described in Note 6, “Variable Interest Entities and Consolidated Investment Products”. The table below includes details of the Company’s investment securities:
 
September 30, 2018
 
December 31, 2017
Investments in equity securities
$
6,263

 
$
4,978

Investments in equity securities accounted for under the equity method
11,941

 

Total investment securities
$
18,204

 
$
4,978


Artisan’s investments in equity securities consist of investments in shares of Artisan Funds, Artisan Global Funds and Artisan sponsored private funds. As of January 1, 2018, the Company adopted ASU 2016-01, which requires all equity investments to be measured at fair value with changes in the fair value recognized through net income.
The table below presents the Company’s gains and losses that relate to seed investments for the specified periods:
 
 For the Three Months Ended September 30,
 
 For the Nine Months Ended September 30,
 
2018
 
2018
Net gains (losses) recognized on investment securities
$
967

 
$
1,592

Less: Net realized gains (losses) recognized on investment securities sold during the period
$

 
$

Unrealized gains (losses) recognized on investment securities held as of the end of the period
$
967

 
$
1,592


Note 4. Fair Value Measurements
The table below presents information about Artisan’s assets and liabilities that are measured at fair value and the valuation techniques Artisan utilized to determine such fair value. The financial instruments held by consolidated investment products are excluded from the table below and are presented in Note 6, “Variable Interest Entities and Consolidated Investment Products”.
In accordance with ASC 820, fair value is defined as the price that Artisan would receive upon selling an investment in an orderly transaction to an independent buyer in the principal or most advantageous market for the investment. The following three-tier fair value hierarchy prioritizes the inputs used in measuring fair value:
Level 1 – Observable inputs such as quoted (unadjusted) market prices in active markets for identical securities.
Level 2 – Other significant observable inputs (including but not limited to quoted prices for similar instruments, interest rates, prepayment speeds, credit risk, etc.).
Level 3—Significant unobservable inputs (including Artisan’s own assumptions in determining fair value).

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The following provides the hierarchy of inputs used to derive fair value of Artisan’s assets and liabilities that are financial instruments as of September 30, 2018 and December 31, 2017:
 
Assets and Liabilities at Fair Value
 
Total
 
NAV Practical Expedient (No Fair Value Level)
 
Level 1
 
Level 2
 
Level 3
September 30, 2018
 
 
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
 
 
Money market funds
$
87,364

 
$

 
$
87,364

 
$

 
$

Equity securities
18,204

 
11,941

 
6,263

 

 

 
 
 
 
 
 
 
 
 
 
December 31, 2017
 
 
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
 
 
Money market funds
$
26,727

 
$

 
$
26,727

 
$

 
$

Equity securities
4,978

 

 
4,978

 

 


Fair values determined based on Level 1 inputs utilize quoted market prices for identical assets. Level 1 assets generally consist of money market funds, open-end mutual funds and UCITS funds. Equity securities without a fair value level consist of investments in sponsored private funds, which are measured at the underlying funds’ net asset value (“NAV”), using the ASC 820 practical expedient. The NAV is provided by the fund and is derived from the fair values of the underlying investments as of the reporting date. Cash maintained in demand deposit accounts is excluded from the table above.
Note 5. Borrowings
Artisan’s borrowings consist of the following as of September 30, 2018 and December 31, 2017:
 
Maturity
 
Outstanding Balance
 
Interest Rate Per Annum
Revolving credit agreement
August 2022
 
$

 
NA

Senior notes
 
 
 
 
 
Series B
August 2019
 
50,000

 
5.32
%
Series C
August 2022
 
90,000

 
5.82
%
Series D
August 2025
 
60,000

 
4.29
%
Total borrowings
 
 
$
200,000

 
 

The fair value of borrowings was approximately $201.8 million as of September 30, 2018. Fair value was determined based on future cash flows, discounted to present value using current market interest rates. The inputs are categorized as Level 2 in the fair value hierarchy, as defined in Note 4, “Fair Value Measurements”.
Interest expense incurred on the unsecured notes and revolving credit agreement was $2.7 million for the three months ended September 30, 2018 and 2017, and $8.0 million and $8.2 million for the nine months ended September 30, 2018 and 2017, respectively.
As of September 30, 2018, the aggregate maturities of debt obligations, based on their contractual terms, are as follows:
2018
$

2019
50,000

2020

2021

2022
90,000

Thereafter
60,000

Total
$
200,000



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Note 6. Variable Interest Entities and Consolidated Investment Products
Artisan serves as the investment adviser for various types of investment products, consisting of both VIEs and VOEs. Artisan consolidates an investment product if it has a controlling financial interest in the entity. Any such entities are collectively referred to herein as consolidated investment products or CIPs.
As of September 30, 2018, Artisan is considered to have a controlling financial interest in three sub-funds of Artisan Global Funds and certain Artisan sponsored private funds related to one investment strategy for which it serves as investment manager. As of September 30, 2018, Artisan’s direct equity investment in the consolidated investment products was $31.0 million.
Artisan’s maximum exposure to loss in connection with the assets and liabilities of CIPs is limited to its direct equity investment, while the potential benefit is limited to the management fee and incentive allocation received and the return on its equity investment. With the exception of Artisan’s direct equity investment, the assets of CIPs are not available to Artisan’s creditors, nor are they available to Artisan for general corporate purposes. In addition, third-party investors in the CIPs have no recourse to the general credit of the Company.
Management fees and incentive allocations earned from CIPs are eliminated from revenue upon consolidation. See Note 15, “Related Party Transactions” for additional information on management fees and incentive allocations earned from CIPs.
Third-party investors’ ownership interest in CIPs is presented as redeemable noncontrolling interest in the Unaudited Consolidated Statements of Financial Condition as third-party investors have the right to withdraw their capital, subject to certain conditions. Net income attributable to third-party investors is reported as net income attributable to noncontrolling interests - consolidated investment products in the Unaudited Consolidated Statement of Operations.
During the three months ended September 30, 2018, the Company determined that it no longer has a controlling financial interest in one private fund as a result of third party capital contributions to the fund. As a result, the VIE was deconsolidated and the following assets, liabilities and noncontrolling interest balances were removed from the Company’s Consolidated Statements of Financial Condition:
 
As of July 1, 2018
Assets of consolidated investment products
 
Cash and cash equivalents
$
39,759

Accounts receivable and other
1,340

Investment assets, at fair value
85,626

Less: Amounts reclassified to investment securities
(11,381
)
Total assets
$
115,344

 
 
Liabilities of consolidated investment products
 
Accounts payable, accrued expenses, and other
$
6,385

Investment liabilities, at fair value
29,328

Total liabilities
$
35,713

 
 
Redeemable noncontrolling interests
$
79,631

 
 
Total liabilities and equity
$
115,344


There was no net impact to the Condensed Consolidated Statements of Operations for the nine months ended September 30, 2018 from the deconsolidation of the private fund. Artisan generally does not recognize a gain or loss upon deconsolidation of investment products as the assets and liabilities of CIPs are carried at fair value. Artisan’s direct equity investment was reclassified from investment assets of consolidated investment products to investment securities. The direct equity investment in the private fund was $11.9 million as of September 30, 2018, which is accounted for under the equity method of accounting since Artisan retains significant influence over the fund.

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Fair Value Measurements - Consolidated Investment Products
The carrying value of CIPs’ investments is also their fair value. Short and long positions on equity securities are valued based upon closing prices of the security on the exchange or market designated by the accounting agent or pricing vendor as the principal exchange. The closing price may represent last sale price, official closing price, a closing auction or other information depending on market convention. Short and long positions on fixed income instruments are valued at market value. Market values are generally evaluations based on the judgment of pricing vendors, which may consider, among other factors, the prices at which securities actually trade, broker-dealer quotations, pricing formulas, estimates of market values obtained from yield data relating to investments or securities with similar characteristics and/or discounted cash flow models that might be applicable.
The following tables present the fair value hierarchy levels of assets and liabilities held by CIPs measured at fair value as of September 30, 2018 and December 31, 2017:
 
Assets and Liabilities at Fair Value
 
Total
 
Level 1
 
Level 2
 
Level 3
September 30, 2018
 
 
 
 
 
 

Assets
 
 
 
 
 
 
 
Money market funds
$
9,693

 
$
9,693

 
$

 
$

Equity securities - long position
7,435

 
7,435

 

 

Fixed income instruments - long position
57,137

 

 
56,312

 
825

Derivative assets
476

 

 
476

 

 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
Equity securities - short position
$
232

 
$
232

 
$

 
$

Fixed income instruments - short position
21,236

 

 
21,236

 

Derivative liabilities
217

 

 
217

 


 
Assets and Liabilities at Fair Value
 
Total
 
Level 1
 
Level 2
 
Level 3
December 31, 2017
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
Money market funds
$
21,881

 
$
21,881

 
$

 
$

Equity securities - long position
69,044

 
69,044

 

 

Fixed income instruments - long position
45,758

 

 
45,758

 

Derivative assets
343

 
303

 
40

 

 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
Equity securities - short position
$
29,199

 
$
29,199

 
$

 
$

Fixed income instruments - short position
18,513

 

 
18,513

 

Derivative liabilities
145

 
45

 
100

 

CIP balances included in the Company’s Consolidated Statements of Financial Condition were as follows:
 
September 30, 2018
 
December 31, 2017
Net CIP assets included in the table above
$
53,056

 
$
89,169

Net CIP assets not included in the table above
8,640

 
8,762

Net CIP assets
61,696

 
97,931

Less: redeemable noncontrolling interest
30,681

 
62,581

Artisan’s direct equity investment in CIPs
$
31,015

 
$
35,350



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Note 7. Noncontrolling interest - Holdings
Net income attributable to noncontrolling interests - Artisan Partners Holdings in the Unaudited Consolidated Statements of Operations represents the portion of earnings or loss attributable to the equity ownership interests in Holdings held by the limited partners of Holdings. As of September 30, 2018, APAM held approximately 70% of the equity ownership interests in Holdings.
In order to maintain the one-to-one correspondence of the number of Holdings partnership units and APAM common shares, Holdings will issue one general partner (“GP”) unit to APAM for each share of Class A common stock issued by APAM. For the nine months ended September 30, 2018, APAM’s equity ownership interest in Holdings has increased as a result of the following transactions:
 
Holdings GP Units
Limited Partnership Units
Total
APAM Ownership %
Balance at December 31, 2017
50,463,126

25,106,719

75,569,845

67
%
2018 Follow-On Offering
644,424

(644,424
)

1
%
Holdings Common Unit Exchanges
1,538,916

(1,538,916
)

2
%
Issuance of APAM Restricted Shares (1)
1,517,724


1,517,724

%
Restricted Share Award Net Share Settlement (1)
(77,442
)

(77,442
)
%
Forfeitures of Holdings GP Units from Employee Terminations (1)
(67,255
)

(67,255
)
%
Balance at September 30, 2018
54,019,493