Artisan Partners Asset Management Inc

NYSE:APAM

Earnings Call Transcript 2017-Q4

[Operator]

Hello, and thank you for standing by. My name is Chad and I will be your conference operator today. At this time, all participants are in a listen-only-mode. [Operator Instructions] After the prepared remarks, management will conduct a question-and-answer Session and conference participants will be given instructions at that time. As a reminder, this conference call is being recorded.

At this time, I will turn the call over to Makela Taphorn, Director of Management Reporting at Artisan Partners. Please go ahead.

[Makela Taphorn, Director of Management Reporting]

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. Following these remarks, we will open the line for questions. Before Eric begins, I would like to remind you that our earnings release and the related presentation materials are available on the Investor Relations section of our website.

Also, the comments made on today's call and some of our responses to your questions may deal with forward-looking statements which are subject to risks and uncertainties. Factors that may cause our actual results to differ from expectations are presented in the earnings release and are detailed in our filings with the SEC. We undertake no obligation to revise these statements following the date of this conference 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.

[Eric Colson]

Thank you, Makela, and thank you everyone for joining the call. Next month will be the fifth anniversary of our IPO. Our transition to a public company structure was important to the evolution of our business. We've retained our independence and culture while establishing an employee equity structure that allows us to evolve and grow our business.

Over the five years since our IPO, we have seen dramatic changes in the investment management industry. The rotation to active to passive has accelerated. Risk based asset allocations continue to gain popularity as the expense of the style box approach. And the demand for ETS and other efficient investment vehicles has grown. In navigating these changes to meet client needs and at the same time evolving our ownership structure, we are proud that we have stayed faithful to who we are. We've remained focused on generating high value added investment returns by creating the best environment for our investment talent. We have also evolved our business in important ways and consistent with who we are. We have added more degrees of freedom to our investment strategies and we have opportunistically sourced talent from new places and backgrounds.

Since 2013, we have added three new investment teams and six new strategies including our first two credit strategies and our first two private funds. We have also expanded our distribution capabilities so that we are now distributing our strategies more broadly than even before. Since 2013, our AUM from clients outside of the U.S. has increased from 7.9 billion across 32 relationships to 22.7 billion across 128 relationships.

Slide 2 shows the investment results, net of fees for Artisan's 13 existing strategies launched prior to 2017. To give you a different view of our business, we have grouped the strategies by U.S., non-U.S. oriented and outcome oriented, which doesn't include the Thematic Team's strategies or the Credit Team's private strategy, all three of which were launched in 2017.

We have also included style benchmarks were relevant. Any consideration of investment performance must be in reference to a time period. At Artisan, we evaluate performance over full market cycles for a long time period.

Over short time periods, markets can be influenced by extremes. In such periods, the only thing we can really control is the steady application of the investment process. Most of our clients are institutional investors or have institutional life decision making process. These clients demand process integrity which our teams maintain through different market environments while exercising judgment under the particular circumstances.

Over longer periods, you can see that our strategies have produced solid, absolute and relative performance. And other strategies have track records of more than 10 years, of those nine have outperformed either their broad or style benchmark since inception and after fees.

In the value added column on the right, you can see that the magnitude of Artisan's outperformance has been greater than the magnitude of underperformance where it exists. All in all, we are very proud of the investment performance across all of our strategies.

Now shown on this page, the performance of our four newer strategies each launched in 2017. Those strategies have good early performance which we expect will begin to translate into client demand later this year and into next.

Slide 3 shows how long term performance can compound wealth for clients. It also shows the opportunity cost of investing in the path of indexes. This chart shows the growth of a hypothetical Artisan portfolio consisting of 1 million invested at the inception of each of our 15 existing and historically marketed strategies launch prior to 2017. A hypothetical Artisan portfolio would have grown from a 15 million initial investment to approximately 73.5 million at the end of 2017 after fees. The Artisan portfolio would have generated about 23 million, approximately 50 more wealth than a portfolio consisting of a broad based passive indexes.

When compounded over a long time periods, even relatively small amounts of annual or short term Alpha can result in significantly greater wealth for clients. Active management as we practice it has worked for clients. We exist as a firm for the purpose of generating the wealth modelled on this slide and the long term results shown on the prior slide.

Moving to Slide 4. Over the last five years, we have averaged about 1.6 billion in firm-wide net outflows per year. Firm-wide totals though can feel more than they explain. First and foremost, we are managing more wealth for clients today than ever before. Between 2013 and the end of 2017, our AUM increased by 41.2 billion, from 74.3 billion to 115.5 billion.

Second, our global strategies have attracted assets very nicely over the last five years. We began launching the global strategies a decade ago when we saw our teams' global research align with the client demand for Global Equity. The investment in the global strategies has worked well for clients, our investment talent and our firm. Today, our outcome oriented strategies are similar to the global strategies a decade ago. We have developed these strategies to align well with the evolving asset allocations, the strategies combined fraud investment flexibility and focus risk management to create portfolios that are unique sources of Alpha which are difficult to replicate with path of indexes.

So far, we have seen strong early demand, the high income and Developing World strategies have attracted assets at a faster rate than any strategies in our history. The Credit, Developing World and Thematic Team are laying the foundation in terms of people, process, culture and results for a long term franchise development and growth.

The client demand for our global and outcome oriented strategies has been offset by net outflows in other areas, primarily U.S. Midcap value and U.S. Midcap growth. We believe that this is the only significant area of our business facing both cyclical performance and secular industry issues.

The outflows from the Midcap strategies as a result of a confluence of factors. One, corporate relative performance over the last several years. Two, client profit taking due to strong absolute returns. And three, changes in asset allocation into the fine contribution marketplace. Both the U.S. Value Team and the Growth Team have outstanding long term track records. And both have worked through periods of underperformance in the past. With improved performance, we believe there will remain demand for these strategies into the future.

Outside of the domestic Midcap space, the flows we have seen over the last five years reflects sustainable demand for high value added active strategies with compelling track records.

Turing to Slide 5, Just like our investment strategy line up, we are confident in our approach to distribution and how we deliver our investment capabilities to clients. We have always expected the same fore swim on the basis of investment results, not distribution or marketing might, our approach to a line investment talent with the needs of sophisticated assets allocators. Once we do that we work to give clients the most transparent and efficient access to our investment capabilities.

We try to maintain simple and straightforward investment vehicles, share classes and distribution and marketing relationships. At the end of 2017, 46% of our AUM was managed in separate accounts. The terms of which are individually negotiated with and fully transparent to clients. Another 20% of our AUM was managed in the institutional share class of Artisan Partners Funds.

Unlike some institutional share classes, Artisan institutional shares do not include any payments to intermediaries. To use the recently popular terminology, our institutional share class is a clean share class. It has been that way since it was first introduced for Artisan international fund in 1997. I would also note that we launched the advisor shares in 2014 in response to demand from intermediaries partners for a share class with lower intermediary payments and none of the Artisan fund share classes have ever include sales loads or 12B1 fees.

We welcome changes across the financial service industry to make it easier for investors to compare performance and fees. As our investment strategies and client demand continue to evolve, we remained open minded and flexible about investment vehicles. With UCITs, CITs, advisor shares and now private funds, we have demonstrated our willingness and ability to use a verity of vehicles when it makes sense for the investment strategy and the client.

Slide 6 provide some perspective on the overall opportunities. The precise numbers and percentages are not that important. What's important is that there is a massive demand for investment management around the world. Global AUM is estimated at approximately 76 trillion representing only about 25% of total worldwide financial assets. The existing 76 trillion marketplace is experiencing an ongoing disruption. We expect investors will continue to ship the way from traditional active managers with hugged benchmarks far too long. Not all of those investors will go pass this. Our experience over the last several years supports our belief that many of those investors will select managers who offer differentiated strategies with high degrees of freedom and strong track records. The traditional active opportunity set is and we expect will remain massive.

We also expect alternative strategies to continue to attract assets given their differentiated returns and risk management features. By adding degrees of freedom to our existing and new strategies and launching our first two private funds, we have evolved our business into the shaded portion of the asset allocation diagram. By doing so, even as traditional actives markets has declined, we have increased our opportunity set.

And importantly, we have evolved in the direction that aligns with our core commitment, the high value added, talent driven investing. Artisan's business model has worked across eight investment teams with separate and distinct decision makers, philosophies and process across multiple assets classes and time periods. We are confident that our investment teams and business model continue to have success. We are also confident that the client demand for Alpha generating firms will persist and potentially increase when conditions normalize.

I'll now turn it over to C. J. to discuss our recent business and financial outcomes.

[C. J. Daley]

Thanks Eric. Good morning, everyone. Financial results for the quarter and the year presented on Slide 7 and include both GAAP and adjusted results. I'll focus most of my comments on adjusted results which we as management utilize to evaluate our business operations.

2017 was a strong year for Artisan. The firm added our eighth investment team and launched four new investment strategies. Assets under management increased 19% to end the year and 115.5 billion, as a result of positive market returns included strong Alpha generation.

Revenues for the year rose 10% and adjusted operating income rose 14% as we realize scale from higher AUM levels ending the year with a higher adjusted operating margin of 37.6%.

Our adjusted results exclude the impacts of Tax Reform enacted in the fourth quarter of 2017. As a result of rat reform, the Company reported a $62 million non-cash GAAP charge in the December quarter from the revaluation of differed tax assets and liabilities. The net amount of 62 million is comprised of a 352 million non-cash tax expense related to lower tax benefits primarily from our TRA related differed tax assets, offset impart by a $290 million non-cash benefit from the corresponding reduction in the amounts payable under the tax receivable agreements. We currently estimate that our adjusted effective tax rate will be 23.5% in 2018.

A summary of AUM is on Slide 8. Quarter end assets of 115.5 billion were up 2% compared to last quarter end. The increase in the current quarter reflected market appreciation of 4.3 billion, offset impart by 2.5 billion of net client cash outflows. For the year, AUM increased 19% as a result of $24 billion of market appreciation, offset impart by net client cash outflows of 5.4 billion.

Net client cash outflows were primarily in non-U.S. growth, U.S. Midcap growth and U.S. Midcap value strategies due to short term underperformance and structural headwinds and traditional loan only and defined contribution markets. Partially offsetting outflows were client cash inflows and global opportunities Developing World and high income strategies.

As a reminder, the current quarter's growth client cash outflows included the impact of Artisan Funds annual income and capital gains distributions which were approximately 510 million net of amounts reinvested in the Funds.

Our financial results begin on Page 9. In the current quarter, revenues grew 3% from the previous quarter and 16% from the same quarter last year. Both were generally in line with the increase is average AUM for those periods. For the year, average AUM increased 13% and revenues increased 10% reflecting a lower average management fee which declined slightly due to the mix of our AUM as a higher proportion of assets under management are in separate accounts.

Operating expenses are summarized on Page 10. Adjusted operating expense this quarter were up 5% compared to last quarter as a result of higher incentive compensation on increased revenues, technology and travel expenses. The increases are reflective of an increase level business activity in the fourth quarter.

Adjusted operating expenses increased 8% for the year also as a result of higher revenue based incentive compensation expense as well as equity based compensation expense related to the 2017 equity grants to employees in cost associated with the addition of our eighth investment team and the launch of four new strategies.

These increased expenses were offset impart by lower third party intermediary distribution expense.

The details of our compensation and benefits expenses are broken out on Slide 11. As a result of the increase in incentive compensation expense in the current quarter, our compensation ratio rose slightly to 48.4% from 48.1% in the previous quarter and was down from 50% in the same quarter last year. Our annual compensation ratio declined slightly to 49% in the current year compared to 49.4% last year.

As a reminder, our compensation ratio runs higher in the March quarter of each year due to increased equity based compensation expense from January equity grants and seasonal compensation cost.

Last week, our Board of Directors approved the grant of approximately 1.5 million of restricted shares to our employees which was approximately $11 million in non-cash equity based compensation expense in 2018. 2 million of this expense will fall on the March quarter and 3 million each of the other quarters of 2018.

We expect that equity based compensation expense which has gradually increased as we have layered on expense for annual equity grants will reach its peak of 15 million in the June 2018 quarter and then decline to 13 million in the September quarter and 11 million in the December quarter.

The seasonal benefits related costs which include employer contributions to health and retirement plans and payroll taxes typically increase competition expense by about 3 million in the first quarter of each year. Another 1 million of seasonal expenses related to non-employee director compensation is recorded in G&A.

Moving on to Page 12. Adjusted operating margin in the current quarter was 38.6% and 39.4% last quarter. The decrease is primarily the result of slightly higher expenses in the quarter from increased business activity. For the year, adjusted operating margin improved to 37.6% from 36.4% last year.

Looking forward to 2018, we have identified a number of strategic incremental initiatives which we consider reinvestments in our business to support current and future growth. In the area of technology, we expect approximately $1 million of additional run rate cost in 2018 and an extra of $4 million of onetime upfront expenses related to the implementation in cost, the risk management and regulatory initiatives mostly to further support expanding degrees of investment freedom. We also plan to implement a new client reporting system which will enhance the client experience.

In addition, we expect three of our investment teams to relocate to new office space this year. As you know part of our autonomous model is derived each investment team with its own four walls for the team to develop and cultivate its own unique culture. We expect the relocations to increase run rate occupancy cost by approximately $2 million per year and we expect to incur approximately $4 million of nonrecurring lease breakage and accelerated depreciation costs related to the moves in 2018.

Finally, as mentioned previously, we expect our adjusted effective tax rate to decline to 23.5% as a result of the passage of the Tax Reform bill. Based on current estimates, we anticipate the corporate tax rate reduction will generate an additional $0.55 per share of adjusted earnings. The tax savings will provide us with the opportunity to further invest in our business and increase dividends to shareholders. The investment initiatives outlined earlier are consistent with our long term priorities and will offset only a small portion of a positive impact of corporate Tax Reform.

Last week, we announced that our Board of Directors declared a quarterly dividend of $0.60 per share and a special annual dividend of $0.79 both payable on February 28 to shareholders of record on February 14. The quarterly dividend and special dividend do not contemplate the cash benefits we expect to realize from Tax Reform in 2018.

It has been our practice to distribute the majority of the cash we generate in the form of regular and special annual dividends. The $3.19 of quarterly and special annual dividends distributed with respect to 2017 represents 2017 adjusted earnings per share of $2.41 plus non-cash expenses and deferred taxes, plus approximately $0.25 of cash retained from prior year earnings and tax savings realized in 2017 after payments under our tax receivable agreements.

As the impact of Tax Reform become clear over the course of the year, we plan to reassess our capital management policy including the levels of our current quarterly and special annual dividend. We also plan to consider transitioning to a variable quarterly cash dividend that would more directly align our quarterly dividend with the earnings we generate each quarter.

We believe a variable dividend policy will provide shareholders with a greater appreciation of our quarterly cash generation allow us to more timely return capitals shareholders and in general be a better reflection of who we are and how we operate our business. Of course, we may determine not to make any changes to our quarterly dividend rate or policies.

Our balance sheet highlights on Page 14 remained strong. Our cash position is healthy and leverage remains modest. As you're aware our employee partners are generally restrictive in selling more than 15% of their pre-IPO equity in anyone year period. The one year period resets in the first quarter of each year. In total, together with shares eligible for sale from retiring employee partners and shares that previously became eligible for sale, approximately 5.5 million shares are eligible for sale in the first quarter.

As part of the first quarter liquidity, several senior portfolio managers will have the ability to sell 20% of their remaining pre-IPO equity as opposed to the standard 15% per year. Existing and retired employee partners are not required to sell any shares and we don't know how many shares they will choose to sell.

Related to Partner liquidity, we expect the ownership of our pre-IPO employee partners to fall below 20% before the end of the first quarter which means that our Class B shares will revert to 1 vote per share from the current 5 votes per share. At that point, all APAM shares will have prorate of voting rights and our three person stockholders committee will go from greater than 50% voting power to approximately 20% voting power. The Class B super vote was designed to ease our transition into the public company structure and minimize disruption to our clients and talent.

We intentionally designed a super vote to expire at a future date when employee partner ownership fell below 20%. We believed at the time of our IPO and still believe today the transitioning overtime, so that voting rights are commensurate with economic rights is good corporate governance.

We look forward to your questions and I will now turn the call back to the operator.

[Operator]

Thank you. We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Michael Carrier with Bank of America Merrill Lynch. Please go ahead.

[Michael Carrier, Bank of America Merrill Lynch]

Thanks guys. First question Eric, just, when you went through some of the strategies and where you're seeing the outflows versus the growth opportunities, just wanted to get an update on when you look at the Midcap strategies, I guess how much of a headwind we can see the aisle in there but probably on the opposite side, where are you seeing the opportunities for growth, which strategies are capped or closed you need a new money. Just trying to get a sense of maybe when that inflection going to happen, where the growth starts to offset some of the headwinds that you noticed?

[Eric Colson]

Yeah, sure, Mike. There's obviously two levers there, the outflow and inflow and we addressed the Midcap outflow and. Now just given a combination of the absolute performance that asset classes generated over the last few years, I mean you just look at that five year time period of producing 15% in that asset class and they put on top the success of our Midcap value and Midcap growth. Any slight change in asset allocation or preference for proprietary target date has exacerbated the flows there. So we think that and in the Midcap value have subsided and with Midcap growth, we still have a good size of BC asset in there as well as some headwinds. But to offset that we have been in the Midcap growth space specifically launch the global discovery to have a more broader view of the Midcap space by creating a global - version of Midcap in some degree and that increases degrees of freedom for that space. Midcaps are fairly rigid category that has more limited degrees of freedom than our other strategies.

So we like the fact that we launch the global discovery to help offset the Midcap grow. And so we think that's one area of an authentic move. And given the success of global opportunities and the Growth Team, we think we're well positioned to mitigate some flows in Midcap or also we're really at nice inflection points for the Credit Team and the Developing World Team given their three and close to three year track record with Developing World that there are right at those inflection points and the institutional marketplace lies to three year track record and process integrity. And we've hit those marks of those strategies.

And it's nice to see some volatility back into the marketplace. Volatility is the friend of active management and so we're - we have a good out left given where those strategy that and where the market is moving towards.

[Michael Carrier, Bank of America Merrill Lynch]

Okay, thanks. And then C. J. you gave a lot of expense guidance. Just on the capital side, when you - you mentioned in terms of the distribution policy just given the tax rate, you are potentially reviewing that, just wanted to get a sense of if you did go to the variable type of distribution, when you think about how much that you are able to payout versus if you look at the growth opportunities in front of Artisan and just how much maybe you see capital that you need or is that already have enough you know that's and that can recycled you know that the distribution of the payout could be close to 100%?

[C. J. Daley]

Yeah, so fundamentally you know Tax Reform doesn't really change how we think about, how we operate the business and where we are going to invest back into the business. From a cash perspective you'll notice that our cash levels are down compared to last year and then that's really reflective of our seeding some of additional strategies we launched four strategies this year, so we stated about $40 million. That money will eventually make its way back in the cash because you know still money is left there for a define period of time you know normally 12 to 24 months.

And in addition, we accelerated some bonus payments to take advantage of the higher tax deduction this year. So our cash level was depressed at the end of this year for those two reasons. The variable dividend the way we think about it is as a private company, we always paid out quarterly dividend after the end of the quarter and we typically paid out 100% of the earnings. As you know we are a low capital intensive business. So we think that and thinking about moving to variable dividend, it would provide a greater appreciation of actual cash generation you know get return capital to our shareholders in a more timely fashion. And really it's a reflection of how we are and how we think about the business. So I don't think our philosophy on returning capital to shareholders has changed at all. It would just be more a timing.

[Michael Carrier, Bank of America Merrill Lynch]

Okay, thanks a lot.

[Operator]

The next question comes from Alex Blostein with Goldman Sachs. Please go ahead.

[Alex Blostein, Goldman Sachs]

Great. Good morning, guys. Just a quick follow-up for your guys on just expense trajectory on, so it sounds like and you guys gave a lot of details around just add some specifics on the occupancy side. But if you look at the non-com bucket, I guess as a whole just kind of excluding distribution expense, what sort of the growth rate you guys expect to see next year and it's going to sounds there is a couple of transitory things in there. How much of they in total as restructured to give our 2019 more of a kind of cleaner run rate what the growth there should be again kind of thinking about whole non-com bucket?

[C. J. Daley]

Yeah, I mean the two areas that I highlighted occupancy and technology and I tried to I did breakout sort of thought were sort of the incremental type cost in 2018 which are quite significant for us. So I think you would - we would expect the trajectory to be back to normal mid-single-digits after you back out those onetime expenses which I highlighted with. They were about 4 million each in occupancy and communications. But then thereafter you know sort of back to normal levels.

[Alex Blostein, Goldman Sachs]

Got it. But I guess this is a normal level being 2017 or part of that like 2017 you guys also have some incremental built out, your build in the teams?

[C. J. Daley]

I mean we did a lot of in 2017 with new team and four new strategies, our first two commercial hedge fund products. So there were some elevation in 2017 as well. It all depends you know if we wind up having another like 2017 I think you would some elevated expenses as well.

[Eric Colson]

Yeah, Alex, it's Eric. We are experiencing some growth what C. J. mentioned with a new teams over the past few years and having a growth mindset given where our performance and our strategies are positioned right now. Looking forward, there is ample examples in that with regards to the Credit Team. And Brian came to me and said that he really wanted to position his franchise to be extremely durable and ready for growth given the performance and the foundation is left. So he requested to move to Denver to get greater access to one just new investment talent, more talent for his team, he feel it's a good location for that. In fact definitely, Well Kansas City a good central part - good central for the country or is not getting the exposure and traffic from consultants and prospects and clients and we think that would pick up. And we also think we'll get more meetings for with company management, self-side and research. And really that was a growth mindset move and we're happy to invest in that.

And we thought the same way with Thematic. It's now in a great spot and we're moving it out to temporary location that we are housing it one of our floors that we had in New York and we've built there four walls and their space that matches who they are and their culture. And these are growth initiatives to our firm and we are happy to reinvest in that. And as C. J. mentioned, if we continue to have a growth orientation, you'll see that expense spend.

[Alex Blostein, Goldman Sachs]

That totally makes sense. Certainly the theme we've heard from a lot of our peers in the space of the last few weeks here. I guess my second question to you guys, Eric kind of duff tails in what you are saying in terms of the build out. As we think about scaling some of the private funds, what's the process you know do you guys think it will be, you need to put a year on this but you now is this is a one to three year process before they start reaching more critical mass just as the fund raising dynamic in those products I know could take a little bit longer or do you think it will - could expense sort of beyond that sort of move the needle?

[C. J. Daley]

Yeah, the private funds don't have the same timeframe as traditional strategies where you tend to need at least a three year record for capacity constrained, liquid oriented strategies and a certain level of assets so that the consultant and other buyers can take off their buy lift criteria. The private fund tend to be shorter than that. And so we wouldn't expect the full three years needed as we would with other strategies. But we do want to be thoughtful on how we move into the space. So we're not looking to take very asset that comes to us. We want to thoughtful of getting the right clients on the right terms that have the right outlook with regards to the time horizon for our strategies.

And we think it's critically important to lay that foundation which I mentioned in my opening remarks about where the Credit Team and where the Developing World and the Thematic Team are as we think we lay in that foundation for a real strong franchise as opposed to getting one product for act. So we're going to have [Technical Difficult]

[Alex Blostein, Goldman Sachs]

Yeah, that makes sense, great. Thanks guys.

[Operator]

Our next question comes from Bill Katz of Citigroup. Please go ahead.

[Bill Katz, Citigroup]

Okay. Thank you very much for taking the question everyone. So couple of things, C. J. let's come back to the capital management discussion a little bit. You sort of talked a little bit about not kind paying the impact of taxes, is there other than the elevated earnings as a result of lower taxes, is there anything else that changes in sort of add backs to get what could be the potential for the quarterly variable dividend?

And then separately, how do you think about repurchase now relative to the variable nature of the dividend given the ongoing drift in the share count?

[C. J. Daley]

Yeah, so, first of I think that the high level answer on the dividend is there is no change in how we think about calculating. We basically look at our adjusted earnings which will include the impacts of the incremental spending that I highlighted add back non-cash expenses, primarily the equity based comp. And then there's some deferred tax which is somewhat immaterial. And the reason I stated that we didn't contemplate the impacts of Tax Reform in the dividend that we just announced. Obviously moving forward, we'll generate more cash as a result of Tax Reform. And we'll think about running the business and our dividend levels the same as we did last year will there just will be more cash available.

[Bill Katz, Citigroup]

You had mentioned that you used have $0.25 this year as some of that reserve. Where's that reserve sand today?

[C. J. Daley]

So, we basically flushed out the reserve we had held, if you recall that was probably a year ago where we're getting a lot of questions around our abilities to sustain our quarterly dividend because our earnings were around the same level. Obviously we had the non-cash expenses which generated cash which weren't in our adjusted earnings for the quarter. So we had held cash back in 2016 and 2017 as an insurance policy for that quarterly. And obviously now we're generating cash flow and excess of that and that's not a question. So again, same philosophy just a larger question there.

[Bill Katz, Citigroup]

Okay. That's helpful. Then Eric, just a big picture for you, I appreciate all the sort of big high - so you see the industry transforming in the evolution of APAM as well. What changes this dynamic then that you sort of you got some pressure on the Midcap side and makes from the style box, legacy style box, small but scaling high yield and it helps for Thematic? Is there anything that else can do to sort of catalyze the growth because when I look at the gross sales of the company that has come down a fair amount over the last year or so. And so the question is, if not now then when, you start sort to see a bit of a bump in the net sales overall?

[Eric Colson]

Yeah, we're seeing the delta is when you really get to large scale account is that we're seeing more competition with regards to feed discounts for those really large accounts. And that's an area we've just held the line on. And so we've held that line on not negotiating steep discounts of, in our minds capacity constraint strategies and everything we do. I mean if we're going to deliver Alpha over the long run, we have to manage the philosophy of assets, we have to manage the mix, we have to manage the absolute AUM and every strategy and we're unwilling to take those large mandates that today's rate.

So the other thing we're doing to offset that is to go deeper and to the intermediary space both in the U.S. and abroad. And we're starting to see some progress outside the U.S. to offset the large mandates that quite frankly, we pass on. You get into a negotiation and you get to a certain rate and at some level, we rather take a pass and just be patient. So we think that in the long run preserving that fee rate, especially if we're delivering the after fee returns that we've delivered and continue to deliver, we would rather be patient to manage that for the long run. And it takes broadly now to the distribution a bit more and having that play through over the next year or two.

[Bill Katz, Citigroup]

Okay. Thank you.

[Operator]

The next question comes from Chris Shutler with William Blair. Please go ahead.

[Chris Shutler, William Blair]

Hey, guys. First, couple of quick clean up questions on the model. So the $4 million of onetime expenses in both tech and occupancy, how should we think about the timing of those expenses hitting the P&L?

[C. J. Daley]

So, I think the occupancy is probably going to be mid-year and technology typically ramps up through the year. So near the end of the year the projects typically ramp up. So I think a little heavier in the mid to end. But admittedly Chris, we don't budget to the month, so those are just sort of high level expectations.

[Chris Shutler, William Blair]

Okay. Fair enough. And then let's see, so I want to get your thoughts on the new factor classification system factor box being marketed by MSCI and Blackrock here recently, is that something that you think is at least the idea is good for the industry, do you think of framing investment performance using that factor land as opposed to style box land is something that's actually going to gain significant traction in the intermediary channel? Thank you.

[Eric Colson]

Sure. Chris, I think that the file boxes were a nice way to categorize various managers that compare and contrast and when style boxes came in and people created style indexes and then the marketplace got quite structured and product then followed suit and created strategies that tracked these style indexes. So I think style factors take that even further. And my view in the industry is going the opposite way with regards to the categorization of products for consultants, clients and intermediaries.

With that being said though that the factors are taking hold in the ETF marketplace and we're seeing those factors causes some volatility even today especially if you lever these factors. And where I think the factors will come through to us is how we analyze, how markets are trading and how some of our teams a look at those factors influencing the portfolio and we'll understand that positioning, are we on the right side of those factors given our philosophy and process. But I don't view the end client or consultant micro-managing asset allocation or manager structure to that level.

[Chris Shutler, William Blair]

Okay. Thanks a lot.

[Operator]

The next question comes from Surinder Thind of Jefferies. Please go ahead.

[Surinder Thind, Jefferies]

Good morning, guys. Just following-up on the discussion around fees in perhaps some of the larger clients asking for discounts in terms of trying to get a new assets. Has there been any discussion around perhaps meeting them part way in the sense that maybe you go to like a performance fee model or something like that were maybe give them the discount but you say hey if we outperform by X then we get to recapture X amount or something like that?

[Eric Colson]

Yes, Surinder, it's Eric. We've always been open to performance based fees and we are having more of those discussions at that account level. Really that the baby comes around, what's the base rate, what's the fulcrum and what's the symmetry around that fulcrum. And those are always the variable that you talk about. And if I had that to look forward and expect that we would see more of a performance based fees out of our traditional and new strategies on a go forward that will be part of the solution.

[Surinder Thind, Jefferies]

Understood. And so I guess just kind of looking at the SME gross sales activity, obviously there been a quite a little past two quarters and this quarter is kind of the lowest in quite some time. So is that part of kind of what's going on in the sense of just there's a lot more discussion around fees that's kind of causing clients to hold off at this point or how should we think about that or is that just kind of the normal ebb and flow for the SME channel?

[C. J. Daley]

I'm not sure if there's any normal ebb and flow for the SMA. We've said it's lumpy, it takes a longer time frame to normalize out. And when you actually win an account and get something own funded report and then look out into the future, you never really know when the exact funding is going to come and how it's going to settle. And it creates that lumpy outcome. So I wouldn't read into a quarter or try to create an SMA pattern. I just haven't seen that over the years in my experience.

[Surinder Thind, Jefferies]

Understood. And then maybe touching based on earlier but your comments about kind of the Midcap products and then maybe if we just focus on the U.S. Value Team. They've maybe stretched struggled a little bit more than some of the other teams and I mean obviously everybody goes through periods of underperformance, but your other teams have bounced that as well but they've tended to bounce back perhaps a lot quicker. Is there any color you can provide on maybe what the delta has been and then maybe with the addition of new PM, I think it was last summer and stuff, if there's any been discussion on the teams investment approach or is it just literally their investment philosophy is just not quite the right fit for the current environment that we're in it at this point?

[C. J. Daley]

I mean clearly that I think the primary discussion is the investment philosophy and process within this nine year bull market that's very narrow and it's had a big impact and it's had a longer and more extended time horizon than past cycles. We always talk about the philosophy a bit it or how to navigate, but yet have integrity and we think of new talent to bring in and to bring fresh new ideas. And that it both those occurred over that timeframe, the individual we brought in Tom Reynolds, who is I think had a nice impact on the team, but it's still early, these things take time. And as the market conditions change and it's not a one way trade, I think this strategy and this team will do quite well. And the Midcap value has been around since 1999, it's produced close to 400 basis points in Alpha and they've been with the same leader on that strategy in the same philosophy and process.

So when clients and consultants look at buying, performance is important. But they want to be ensured that there's a high quality team and process integrity at some place, so that they can evaluate it. We think all that's in place and it really won't take a whole lot for performance to start coming back and for us to be in a positive position with this group.

[Surinder Thind, Jefferies]

Understood. That's helpful. That's it for me. Thank you.

[Operator]

The next question will be from Robert Lee of KBW. Please go ahead.

[Robert Lee, KBW]

Hi, thanks. Good morning, guys. Just curious, maybe Eric, going back to your comments about looking at intermediary channels both the U.S. and outside the U.S. a place where maybe for more emphasis given let's see better fee structure, particularly outside the U.S. so that intermediary challenge has been a pretty expensive place to access and while fees tend to be high, it tends to be a lot of distribution expense around it. So you may be more not only in other specific non-U.S. intermediary channels where you feel like you have a better shower that spending as much as, just trying to get a feel how where you're focused outside the U.S. on expanding intermediary and how we should think of that from kind of an incremental spend beyond what C.J. has mentioned?

[Eric Colson]

Certainly, Rob. The historical fear of the intermediary market in Europe primarily is the number of vehicles, share classes and expense that goes with distributed in a more fragmented marketplace. Our belief is that that's consolidating and the regulatory environment is moving to a more clean share class structure which we see in the U.S. that's happening quite a bit in Europe. And we think that is extremely favorable to our model. And so we're picking and choosing those platforms and partners that fit our institutional mindset. But there will be some additional expense above what we do in the U.S. just given the number of countries you deal with and languages that you have to translate to. So they'll be some I think minor expense on top of that but those are all coming down and that's one of the real reasons we're getting excited about that space is it is coming down in the expenses.

[Robert Lee, KBW]

Okay. Thanks. And maybe at a high level, you gave some good color around some of the challenges faced in Midcap strategies with re-bouncing and what not. But I mean at a high level, could you maybe talk a little bit about kind of more broadly speaking kind of RFP activity that you're seeing out, are you expecting that Global had pretty good run for a while, you expecting to see more re-bouncing there or are you seeing more people come back to active or liquid strategies maybe from even some alternative strategies given I was saying in the last week or so there's seems to still be some optimism about the market outlook for next couple of year or so?

[Eric Colson]

I don't think if we've seen any major change that I can identify. That's going to change the flow dynamic that staring at us today obviously there's volatility creeping into the market and a lot of material written that active is the imposition better than it was before. And I think that active and passive do have cycles. And so we are optimistic about the near term. And I would define that over the next three years to five years, but I don't see any catalyst right in front of us today.

[Robert Lee, KBW]

Hey, thanks. Maybe one last just technical question. With the Class B shares I guess seems poised to convert so one vote. Is that all, is that any kind of change in control from the fund contract perspective, it's going to require some proxies or anything?

[Eric Colson]

No. We've obviously thought about the design of this outcome to minimize disruption for clients prior to the IPO. We've been very thoughtful about this outcome. And it's not going to create a need to have a proxy vote for validating the change of control. So that won't be in place and we've just looked at all the areas that going from private to public, we've just tried to smooth everything and create the outcome to be gradual and thoughtful. And we think that transition for the most part is complete.

[Robert Lee, KBW]

Great. Thanks for taking my question.

[Operator]

The next question will be from Kenneth Lee of RBC Capital Markets.

[Kenneth Lee, RBC Capital Markets]

Hi. Thanks for taking my question. I just had one question on - the follow-up on the non-U.S. client AUM which is the nice growth. I wonder if you can give us a sense of the mix between institutional intermediaries I mean it sounds that it's going towards the intermediary but just want to get a better sense. And also relatedly what particular strategies or products are getting a particular attraction for these non-U.S. clients? Thanks.

[C. J. Daley]

Sure, Ken. The design of going into the non-U.S. distribute marketplace was really through the institutional consultant and our institutional presence. So we have quite a few global consultants that were well positioned with. And if you look back to the launch of our global strategies in our immerging markets that provided for the first time strategies that will be positioned quite well for non-U.S. investors. And so the foundation of our early and continued non-U.S. access is through the institutional marketplace. We have been successful with some intermediaries but we haven't applied the same resources that we apply in the U.S. to outside the U.S. and we're going to uptick our resources towards the intermediary space in Europe and broaden that out for the future.

[Kenneth Lee, RBC Capital Markets]

Gotcha, thanks.

[Operator]

Ladies and gentlemen, this concludes our question-and-answer session and thus concludes today's call. We thank you very much for attending today's presentation. You may now disconnect your lines.