T. Rowe Price Group, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; comparisons are with the three months ended March 31, 2017, unless noted. T. Rowe Price primarily earns investment advisory fees based on assets under management (AUM). The interim financial statements were reviewed by KPMG, not audited.
Financial performance and position
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Net revenues | $1,328.0 million | $1,132.6 million | +17.3% |
| Operating expenses | $744.2 million | $610.9 million | +21.8% |
| Net operating income | $583.8 million | $521.7 million | +11.9% |
| Operating margin | 44.0% | 46.1% | Down 2.1 percentage points |
| Net income attributable to T. Rowe Price | $453.7 million | $385.9 million | +17.6% |
| Diluted EPS | $1.77 | $1.54 | +14.9% |
| Adjusted non-GAAP diluted EPS | $1.74 | $1.18 | +47.5% |
| Operating cash flow, consolidated | $521.0 million | $188.5 million | Increased |
- Average AUM was $1,025.5 billion, up 21.3%; ending AUM was $1,014.2 billion, up 17.7% from March 31, 2017. Q1 net inflows were $11.3 billion, while market appreciation and income contributed $11.8 billion.
- Investment advisory fees rose 19.8% to $1,189.2 million, reflecting higher average AUM. The annualized effective fee rate declined to 47.0 basis points from 47.6 basis points, partly due to fee reductions and a higher share of assets earning lower rates.
- Compensation expense increased 11.1%; technology, occupancy and facility costs rose 13.6%; and general, administrative and other costs rose 26.7%. The company attributed increases to staff growth, strategic initiatives, technology investment, and business and regulatory demands.
- GAAP net income included $16.1 million of non-operating income, versus $115.0 million a year earlier, when investment gains were substantially higher. The 2018 effective tax rate was 24.1%, down from 37.1%, mainly following U.S. tax reform.
- Cash and cash equivalents were $1,681.4 million at quarter-end, versus $1,902.7 million at year-end 2017. The company reported no debt. Cash plus discretionary investments totaled $3,015.4 million; broader cash and investments in T. Rowe Price products totaled $4,423.6 million, but seed capital and consolidated fund assets are not all available for general operations.
- Quarter-end total assets were $7,374.3 million and total liabilities were $925.9 million. Redeemable non-controlling interests were $546.5 million. The filing provides no conventional debt or leverage balance because the company remains debt-free.
- Quarterly dividends declared increased to $0.70 per share from $0.57. The company repurchased 2.9 million shares for $313.5 million during the quarter.
Material changes and unusual items
- Q1 2017 operating expenses included a $50 million insurance recovery related to the Dell appraisal-rights matter. Its absence in 2018 affects year-over-year comparisons. Excluding that recovery, management said operating margin was 41.6% in Q1 2017, compared with 44.0% in Q1 2018.
- ASC 606 adoption increased reported 2017 net revenues and expenses by $19.0 million through gross presentation of certain service reimbursements; management said it did not change revenue-recognition timing or operating income. The company also reorganized expense line items.
- New financial-instrument accounting adopted January 1, 2018 requires substantially all non-consolidated equity investments to reflect fair-value changes in earnings. The adoption included a $14.5 million cumulative retained-earnings adjustment for certain investments and a reclassification of prior unrealized gains.
- Consolidated cash flow comparisons are affected by investment-product activity. On a company-only basis, operating cash flow was $722.9 million versus $728.1 million in Q1 2017; investing cash flow was a $524.3 million use, largely reflecting purchases of investment products.
Outlook, management commentary and risks
- Management expects 2018 non-GAAP operating expenses to grow 8%–11%, including cost-optimization efforts. It anticipates about $180 million of 2018 property and equipment expenditures, roughly two-thirds for technology, funded from operating resources.
- Management estimates a full-year 2018 effective tax rate of 24%–27%; it expects Maryland’s phased-in single-sales-factor tax apportionment change to provide a future net benefit, while assessing the effect.
- Management plans continued investment in investment talent, new strategies and vehicles, technology, and global distribution. AUM, fee revenue and results remain sensitive to markets, client flows, investment performance, fee competition and fund-board decisions.
- Market risks include falling asset values and potential changes in investor flows. The filing describes first-quarter volatility, rising interest rates and trade-policy uncertainty; the potential loss in investment-product holdings was reported as materially unchanged from year-end 2017.
- Pending matters include an ERISA fiduciary-duty and prohibited-transaction lawsuit concerning the company 401(k) plan and a shareholder lawsuit alleging excessive fund advisory fees. The company disputes the claims; it cannot estimate potential losses or predict outcomes.
- The Dell appraisal matter remains contingent on further court proceedings. If clients must repay compensation after a final judgment, the company estimates the first $15.2 million reclaimed would be repaid to T. Rowe Price, with additional amounts directed to insurers under specified terms.
- Management cites ongoing uncertainty around DOL and SEC fiduciary standards, which could affect business activities and costs. The company also plans to adopt lease accounting requirements on January 1, 2019, and expects recognition of operating-lease assets and liabilities.
Key facts for investors to verify
- Whether AUM inflows, investment performance and effective advisory fee rates remain supportive of revenue growth.
- How operating expenses compare with the 8%–11% non-GAAP growth outlook, and whether margin improvement persists after adjusting for the prior-year Dell recovery.
- Whether reported cash and investment balances are available for corporate use, distinguishing company resources from seed capital and consolidated investment-product assets.
- Developments and potential financial effects of the ERISA, excessive-fee and Dell appraisal-rights matters.
- The full-year tax rate, capital expenditures, and the impacts of U.S. tax reform and new lease accounting.