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ART > SEC Filings for ART > Form 10-Q on 9-Nov-2012All Recent SEC Filings

Show all filings for ARTIO GLOBAL INVESTORS INC.

Form 10-Q for ARTIO GLOBAL INVESTORS INC.


9-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations ("MD&A").

Introduction

Artio Global Investors Inc. ("Investors" or the "Company") and subsidiaries (collectively, "we," "us" or "our") comprises Investors and its subsidiaries, including Artio Global Holdings LLC ("Holdings"), an intermediate holding company that owns Artio Global Management LLC ("Investment Adviser"), a registered investment adviser under the Investment Advisers Act of 1940, as amended; Artio Global Institutional Services LLC, which is licensed as a limited-purpose broker-dealer; and certain investment vehicles we consolidate because we have a controlling financial interest in them (the "Consolidated Investment Products"). In April 2012, Richard Pell, our Chief Investment Officer ("Pell"), and Rudolph-Riad Younes, our Head of International Equity ("Younes," together with Pell, the "Principals") exchanged their remaining interests in Holdings for shares of Investors' Class A common stock, leaving Holdings as a wholly owned subsidiary (see Notes to Consolidated Financial Statements, Note 2. Stockholders' Equity). Prior to the exchange, Holdings was approximately 98% owned by Investors and 1% owned by each of the Principals. The Principals' interests were reflected in the consolidated financial statements as Non-controlling interests in Holdings.

Our MD&A is provided in addition to the accompanying consolidated financial statements and footnotes to assist readers in understanding our results of operations and liquidity and capital resources. The MD&A is organized as follows:

General Overview. Beginning on page 31, we provide a summary of our overall business, the economic environment and our business environment.

Key Performance Indicators. Beginning on page 33, we discuss the operating and financial indicators that guide management's review of our performance.

Assets Under Management. Beginning on page 36, we provide a detailed discussion of our assets under management ("AuM"), which is the major driver of our operating revenues and key performance indicators.

Revenues and Other Operating Income. Beginning on page 40, we compare our revenue and other operating income to the corresponding periods a year ago.

Operating Expenses. Beginning on page 41, we compare our operating expenses to the corresponding periods a year ago.

Non-operating Income (Loss). Beginning on page 42, we compare our non-operating income (loss) to the corresponding periods a year ago.

Income Taxes. Beginning on page 42, we compare our effective tax rates to the corresponding periods a year ago.

Liquidity and Capital Resources. Beginning on page 43, we discuss our working capital as of September 30, 2012, and December 31, 2011, and cash flows for the first nine months of 2012 and 2011. Also included is a discussion of the financial capacity available to help fund our future activities.

New Accounting Standards. Beginning on page 45, we discuss new accounting pronouncements that may apply to us.

Cautionary Note Regarding Forward-Looking Statements. Beginning on page 45, we describe the risks and uncertainties that could cause actual results to differ materially from those discussed in forward-looking statements set forth in this Form 10-Q relating to our financial results, operations, business plans and prospects. Such forward-looking statements are based on management's current expectations about future events, which are inherently susceptible to uncertainty and changes in circumstances.

Artio Global Investors Inc. Third Quarter 2012 Form 10-Q 30


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General Overview

Business

We are an asset management company that provides investment management services to institutional and mutual fund clients. We manage and advise proprietary (mutual) funds; commingled institutional investment vehicles; institutional separate accounts; sub-advisory accounts; and a hedge fund. While our operations and clients are primarily U.S.-based, a substantial portion of our AuM is invested outside of the U.S. Our revenues are primarily billed in U.S. dollars and are calculated based on the U.S. dollar value of the investment assets we manage for clients. Our managed portfolios have exposures to currencies other than the U.S. dollar, which can affect our revenues. As of September 30, 2012, 47% of our AuM were exposed to currencies other than the U.S. dollar. Consequently, changes in foreign currency exchange rates will affect our revenues. Our expenses are primarily billed and paid in U.S. dollars and not significantly impacted by foreign currency exchange rates.

For select new product initiatives, we invest in the related investment vehicles in order to provide critical mass. We refer to these investments as "seed money investments." Income from seed money investments is included in non-operating income. This income is, by nature, variable. Since the third quarter of 2010, we have made aggregate seed money investments of $47 million.

Economic Environment

As an investment manager, we derive substantially all of our operating revenues from providing investment management services to our institutional and mutual fund clients. Such revenues are driven by the amount and composition of our AuM, as well as by our fee structure, making our business results sensitive to the prevailing global economic climate and its impact on investor sentiment and capital markets.

In the third quarter of 2012, global markets saw positive returns. The euro zone performed well after the European Central Bank pledged to support the euro by cutting its benchmark interest rate to its lowest level ever and stated that it is prepared to make unlimited purchases of government debt in the open market. Concerns still surround the fiscal rescue of Greece and Spain, and a slowdown in Chinese growth that could impact prospects in Europe and the U.S.

U.S. markets performed strongly in light of a widely anticipated policy announcement by the U.S. Federal Reserve that it will begin expanding its holdings of mortgage-backed securities. Instead of providing a fixed endpoint, however, the U.S. Federal Reserve announced that its open market activity will continue until unemployment drops sufficiently or inflation rises too fast. The outcome of November's presidential election and a compromise to avoid the so-called 'fiscal cliff' continue to weigh on investor sentiment.

Business Environment

The International Equity strategies, which historically comprised the largest percentage of AuM, saw significant net client cash outflows in the first nine months of 2012. By contrast, fixed income strategies only experienced modest net client cash outflows, and with market appreciation, their AuM is now higher than it was at the start of the year. By asset size, as of September 30, 2012, fixed income represents our largest product group. Given this proportional shift and their lower rate fees, asset growth within our fixed income strategies is expected to result in a slower pace of revenue growth than if there was a comparable situation in our equities strategies.

We believe that our fixed income strategies provide our best opportunity for asset growth in the immediate future, but believe this could be tempered by net client cash outflows in our International Equity strategies.

Results for the three months ended September 30, 2012, include expenses associated with winding down our U.S. Equity strategies, as well as other expenses associated with reductions to our cost base to a level consistent with our decreased AuM and associated revenues. These expenses totaled $5.0 million.

31 Artio Global Investors Inc. Third Quarter 2012 Form 10-Q


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We have deferred tax assets totaling $176.5 million that resulted from a step-up in tax basis associated with the conversion of shares by certain shareholders (the "step-up benefits"). These tax benefits are shared with the converting shareholders under a tax receivable agreement (see Notes to the Consolidated Financial Statements, Note 4. Related Party Activities: Tax Receivable Agreement). The amortization of the step-up for tax purposes occurs annually for approximately 15 years in amounts ranging from approximately $23 million to $52 million a year. Our analysis of these benefits shows that while we are likely to utilize the amortization expense to generate tax benefits in the next year, in the years following, we may have difficulty recognizing such benefits. Any unused benefits will then be usable in our tax returns only on a carry-forward basis, for a period of 20 years. We have recorded a valuation allowance of $178.1 million against these deferred tax assets and certain other deferred tax assets, and reduced Due from tax receivable agreementon the Statement of Financial Position by $141.2 million, reflecting our estimate of the amounts of step-up benefits that will not be usable in reducing our tax liability in the years that the amortization takes place.

In connection with a review of our deferred tax assets, we decided in the third quarter of 2012 to eliminate the service requirement for employee stock awards issued at our initial public offering ("IPO"). The cost of the unvested awards, or $17.2 million, was accelerated and is included in the third-quarter 2012 results. The awards will continue to vest according to their original schedule.

Changing and refining our business strategy is only possible with sufficient liquid resources. We generated positive cash flow during the third quarter of 2012 and as of September 30, 2012, had a cash balance of $79.7 million. This provides us with funds for both operating purposes and investment in future growth initiatives.

Artio Global Investors Inc. Third Quarter 2012 Form 10-Q 32


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Key Performance Indicators

Our management reviews our performance on a monthly basis, focusing on the
indicators described below.




(in millions, except basis points, percentages and per           Three Months Ended September 30,                    Nine Months Ended September 30,
share amounts)                                                        2012                      2011                     2012                      2011
 Operating indicators
 AuM at end of period                                           $17,667                      $34,252                $17,667                     $34,252
 Average AuM for period(a)                                       19,171                       41,670                 23,755                      47,829
 Net client cash flows                                           (4,285 )                     (4,183 )              (14,749 )                   (11,941 )
 Market appreciation (depreciation)                                 796                       (8,400 )                2,057                      (7,214 )

 Financial indicators
 Investment management fees                                          26                           66                    103                         226
 Effective fee rate (basis points)(b)                              55.0                         62.4                   57.7                        63.1
 Adjusted operating income(c)                                         1                           32                     17                         113
 Adjusted operating margin(d)                                       4.3 %                       50.0 %                 16.6 %                      50.5 %
 Adjusted EBITDA(c)                                                   3                           35                     25                         121
 Adjusted EBITDA margin(d)                                         10.5 %                       54.4 %                 24.2 %                      54.1 %
 Adjusted compensation ratio(c)(e)                                 53.6 %                       27.8 %                 49.1 %                      29.6 %
 Adjusted net income attributable to Artio Global
Investors(c)                                                          4                           16                     13                          63
 Diluted earnings per share                                    $  (0.87 )                    $  0.11               $  (0.78 )                     $0.85
 Adjusted diluted earnings per share(f)                         $  0.07                      $  0.27                $  0.23                     $  1.06

(a) Average AuM for a period is computed on the beginning-of-first-month balance and all end-of-month balances within the period.

(b) The effective fee rate is computed by dividing annualized investment management fees (normalized for the number of days in the period) by average AuM for the period.

(c) See the "Adjusted Performance Measures" section of this MD&A for reconciliations of Employee compensation and benefits to Adjusted compensation; Operating income before income tax expense to Adjusted operating income; Net income to adjusted Earnings before Interest, Taxes, Depreciation and Amortization ("Adjusted EBITDA"); and Net income attributable to Artio Global Investors to Adjusted net income attributable to Artio Global Investors.

(d) Adjusted operating and Adjusted EBITDA margins are calculated by dividing Adjusted operating income and Adjusted EBITDA by Total revenues and other operating income.

(e) Calculated as Adjusted compensation(c) divided by Total revenues and other operating income.

(f) Adjusted diluted earnings per share is calculated by dividing Adjusted net income attributable to Artio Global Investors by Adjusted weighted average diluted shares (see the "Adjusted Performance Measures" section of this MD&A).

Operating Indicators

Our revenues are driven by the amount and composition of our AuM, as well as by our fee structure. As a result, management closely monitors our AuM. We believe average AuM is more useful than quarter-end AuM in analyzing performance during a period, as most of our fees are calculated based on daily or monthly AuM, rather than quarter-end balances of AuM.

Net client cash flows represent purchases by new or existing clients, less redemptions. Our net client cash flows are driven by a number of factors, including the performance of our investment strategies relative to their respective benchmark and/or peers, absolute levels of performance, the competitiveness of our fee rates, the success of our marketing and client service efforts, clients' appetite for risk and the general state of equity and fixed income markets. Net client cash outflows were $4.3 billion for the three months ended September 30, 2012, and $14.7 billion for the nine months ended September 30, 2012, mostly in our International Equity strategies. In our view, this primarily reflects underperformance in our International Equity strategies during 2009 through 2012.

Financial Indicators

Management reviews certain financial ratios to monitor progress with internal forecasts and our business drivers, and compare our firm with others in the asset management industry. The effective fee rate represents the amount of investment management fees we earn divided by the average dollar value of AuM we manage. This information can

33 Artio Global Investors Inc. Third Quarter 2012 Form 10-Q


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be used as an indicator of the contribution of our products to revenues. Adjusted operating and Adjusted EBITDA margins are important indicators of our profitability and the efficiency of our business model. (See the "Adjusted Performance Measures" section of this MD&A for a discussion of financial indicators not prepared in conformity with U.S. Generally Accepted Accounting Principles ("GAAP").) Other ratios shown in the table on page 33 allow us to review expenses in comparison with our revenues.

Investment management fees are earned from managing clients' assets and fluctuate based on the total value of AuM, composition of AuM among our investment vehicles and among our investment strategies, and changes in the investment management fee rates on our products. Fees from our International Equity strategies are our primary revenue source and as a percentage of Investment management fees were approximately 67% in the first nine months of 2012 and 85% in the first nine months of 2011. The decrease in revenue percentage from our International Equity strategies primarily reflects net client cash outflows in 2011 and the first nine months of 2012.

Our effective fee rate of 55.0 basis points for the third quarter of 2012 has declined in recent quarters due primarily to a greater proportion of our AuM being in fixed income strategies, which typically have lower average fee rates than our equity strategies.

Our Adjusted operating and Adjusted EBITDA margins in the first nine months of 2012 decreased compared to the first nine months of 2011, as revenues declined faster than expenses. We expect our margins to be under pressure during the rest of 2012 and in 2013, given the significant decline in AuM.

Adjusted Performance Measures

Certain of our financial indicators are adjusted versions of balances in our consolidated financial statements and are not prepared in conformity with GAAP. We believe these adjusted financial indicators are meaningful as they are more representative of our ongoing expense base than their GAAP counterparts. We exclude the amortization expense associated with equity awards granted to employees at the time of our IPO in 2009 (since it was awarded as a consequence of our IPO and not in the ordinary course of business), severance and other costs associated with the organizational changes put in place during 2011 and 2012, a valuation allowance on a deferred tax asset (since the deferred tax asset arose primarily out of a stock transaction rather than our operations), expenses related to the winding down of our U.S. Equity strategies and the indemnification of a tax obligation of one of our funds.

We also present Adjusted net income attributable to Artio Global Investors per diluted share, which assumes the full exchange of our Principals' non-controlling interests for Class A common stock at the beginning of each period presented. (This adjustment does not conform with GAAP, for those periods in which the shares are antidilutive. In such periods, the adjustment has the effect of increasing earnings per share.)

These adjustments are reflected in Adjusted operating income, Adjusted operating margin, Adjusted compensation ratio, Adjusted net income attributable to Artio Global Investors, Adjusted EBITDA, Adjusted EBITDA margin and Adjusted diluted earnings per share. Adjusted EBITDA and Adjusted EBITDA margin also exclude non-operating income and the indemnification of a tax obligation of one our funds. We have adjusted Income taxes to reflect the appropriate effective tax rate for each period after taking into consideration these non-GAAP adjustments.

Artio Global Investors Inc. Third Quarter 2012 Form 10-Q 34


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The following table reconciles Employee compensation and benefits to Adjusted compensation, Operating income before income tax expense to Adjusted operating income, Net income to Adjusted EBITDA, and Net income attributable to Artio Global Investors to Adjusted net income attributable to Artio Global Investors.

                                            Three Months Ended September 30,             Nine Months Ended September 30,
(in thousands)                                  2012                   2011                 2012                  2011
 Employee compensation and benefits           $ 38,048              $28,387               $ 79,799             $ 82,217
 Less compensation adjustments:
 Staff reduction costs                           4,637                5,622                  5,502                5,622
 Amortization expense of IPO-related
restricted
stock unit grants ("RSUs")                      19,021                5,052                 23,454               10,320

 Total compensation adjustments                 23,658               10,674                 28,956               15,942

 Adjusted compensation                        $ 14,390              $17,713               $ 50,843             $ 66,275


 Operating income (loss) before
income tax expense                            $(24,106 )            $21,219               $(13,366 )           $ 97,160
 Add: total compensation adjustments            23,658               10,674                 28,956               15,942
 Add: indemnification charge                     1,205                    -                  1,205                    -
 Add: other restructuring charges                  403                    -                    403                    -

Adjusted operating income                     $  1,160              $31,893               $ 17,198             $113,102


Net income (loss)                             $(51,547 )            $ 5,276               $(44,673 )           $ 50,006
 Less: interest income                          (1,810 )             (1,019 )               (3,547 )             (2,314 )
 Add: interest expense                            (125 )                461                    358                1,488
 Add: income taxes                             171,627                9,753                176,662               41,373
 Add: depreciation and amortization             21,590                8,934                 32,242               19,611

 EBITDA                                        139,735               23,405                161,042              110,164
 Add: other non-operating (income)
loss(a)                                       (142,251 )              6,748               (142,166 )              6,607
 Add: staff reduction costs,
excluding amortization                           3,736                4,519                  4,601                4,519
 Add: indemnification charge                     1,205                    -                  1,205                    -
 Add: other restructuring charges                  403                    -                    403                    -

 Adjusted EBITDA                              $  2,828              $34,672               $ 25,085             $121,290


 Net income (loss) attributable to
Artio Global
Investors                                     $(52,107 )            $ 6,413               $(45,972 )           $ 49,595
 Add: total compensation adjustments            23,658               10,674                 28,956               15,942
 Add: non-controlling interests in
Holdings                                             -                  319                    202                1,807
 Add: indemnification charge                     1,205                    -                  1,205                    -
 Add: other restructuring charges                  403                    -                    403                    -
 Add: reduction in liability under
tax receivable agreement                      (141,195 )                  -               (141,195 )                  -
 Tax impact of adjustments                     171,936               (1,492 )              169,874               (3,977 )

 Adjusted net income attributable to
Artio Global
Investors                                     $  3,900              $15,914               $ 13,473             $ 63,367


 Weighted average diluted shares                59,640               58,403                 59,017               58,431
 Adjusted weighted average diluted
shares(b)                                       59,988               59,603                 59,745               59,631

(a) Other non-operating income (loss) primarily represents a reduction in liability under a tax receivable agreement and gains and losses on investments of the Consolidated Investment Products.

(b) Adjusted weighted average diluted shares for periods prior to the Principal's exchanges in April 2012 assumes the Principals have fully exchanged all of their non-voting Class A membership interests in Holdings ("New Class A Units") for Class A common stock. The additional shares are antidilutive in accordance with GAAP. Adjusted weighted average diluted shares for the three months and nine months ended September 30, 2012, include the dilutive impact of the unvested RSUs which are anti-dilutive under GAAP.

35 Artio Global Investors Inc. Third Quarter 2012 Form 10-Q


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Assets under Management ("AuM")

Changes to our AuM, the distribution of our AuM among our investment products and investment strategies, and the effective fee rates on our products, all affect our operating results from one period to another.

The amount and composition of our AuM are influenced by a variety of factors including, among other things:

investment performance, including our investment decisions and fluctuations in both the financial markets and foreign currency exchange rates;

client cash flows into and out of our investment products;

the mix of AuM among our various strategies; and

our introduction or closure of investment strategies and products.

During the nine months ended September 30, 2012, we managed assets across 10 different strategies, within six asset classes, including:

High Grade Fixed Income;

High Yield;

Emerging Markets Local Currency Debt;

International Equity;

Select Opportunities (formerly Global Equity); and

U.S. Equity.

In the third quarter of 2012, we made the decision to discontinue our four U.S. Equity strategies. The AuM of these strategies was $28.9 million as of September 30, 2012.

The following table sets forth a summary of our AuM by investment vehicle type as of September 30, 2012 and 2011.

                                              As of September 30,                    As a % of AuM as of September  30,
(in millions, except percentages)          2012                 2011                    2012                     2011

Proprietary Funds(a)
 A shares                                $ 2,548              $  4,706
 I shares(b)                               6,372                10,758

 Total                                     8,920                15,464                 50.5 %                     45.2 %
Institutional commingled funds             2,598                 5,769                 14.7                       16.8
Separate accounts                          5,194                10,838                 29.4                       31.6
Sub-advisory accounts                        955                 2,181                  5.4                        6.4

Ending AuM                               $17,667               $34,252                100.0 %                    100.0 %

(a) Proprietary Funds include both SEC-registered funds and private offshore funds. SEC-registered mutual funds within our proprietary funds are: Artio International Equity Fund; Artio International Equity Fund II; Artio Total Return Bond Fund; Artio Global High Income Fund; Artio Select Opportunities Fund Inc.; Artio Emerging Markets Local Currency Debt Fund ("EMLCDF"); and . . .

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