T. Rowe Price Group, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. The company earns most revenue from investment advisory services; fees are closely tied to assets under management (AUM), market performance and client flows. Amounts below are U.S. dollars.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net revenues | $1,345.0 million | $1,186.0 million | $2,673.0 million | $2,318.6 million |
| Net operating income | $594.7 million | $507.6 million | $1,178.5 million | $1,029.3 million |
| Net income attributable to T. Rowe Price | $448.9 million | $373.9 million | $902.6 million | $759.8 million |
| Diluted EPS | $1.77 | $1.50 | $3.55 | $3.04 |
| Operating margin, as reported by management | 44.2% | 42.8% | 44.1% | 44.4% |
- Q2 investment advisory fees increased 16.1%; average AUM rose 17.0% year over year to $1,036.5 billion. Ending AUM was $1,044.1 billion, up $53.0 billion from year-end 2017. Net cash inflows were $7.6 billion in Q2 and $18.9 billion in the first half.
- The annualized effective advisory fee rate was 47.0 basis points in Q2, down from 47.4 basis points a year earlier. Management cited fee reductions and client transfers to lower-fee vehicles, partly offset by a higher mix of equity strategies.
- Q2 operating expenses increased 10.6% to $750.3 million; non-GAAP expenses rose 10.1% to $745.3 million. Management attributed growth principally to market-driven costs and strategic investment. Q2 GAAP net income grew 20.1% and diluted EPS grew 18.0%.
- Q2 non-operating income fell to $34.1 million from $112.0 million, largely because prior-year results included investment gains that were not repeated and consolidated investment products produced lower gains. The first-half comparison also reflects $50.0 million of Dell-related insurance recoveries recorded in 2017.
Cash flow, balance sheet and capital
- At June 30, 2018, cash and cash equivalents were $1,484.4 million, versus $1,902.7 million at December 31, 2017. Investments were $2,459.5 million, versus $1,477.3 million. Management said the company remained debt-free with ample liquidity.
- Total assets were $7,882.2 million; total liabilities were $1,028.4 million. Redeemable non-controlling interests were $739.2 million and permanent stockholders’ equity was $6,114.6 million.
- For the first half, reported consolidated operating cash flow was $929.3 million, compared with $139.2 million in 2017; investing cash flow was negative $944.0 million, compared with positive $137.6 million. The company attributed the investing outflow largely to reallocating $945.0 million from cash into T. Rowe Price fixed-income funds. These consolidated cash-flow figures include investment-product activity; cash flow attributable to the parent from operations was $1,328.6 million.
- First-half dividends paid were $348.7 million and share repurchases were $450.3 million (4.2 million shares, average $106.48). The quarterly recurring dividend was increased 22.8% to $0.70 per share in March.
Outlook, notable items and risks
- Management expected 2018 non-GAAP operating expenses to grow 8%–11%, factoring in cost-optimization efforts and contemplated uses of U.S. tax-reform benefits. Estimated full-year effective tax rate was 24%–27%. Planned 2018 property and equipment expenditures were about $189 million, roughly two-thirds for technology initiatives.
- Q2 included nonrecurring tax charges of $20.8 million related to U.S. tax reform and $7.9 million related to Maryland tax legislation. The company expected the Maryland legislation to provide a net benefit over time; estimates remained subject to interpretation and further guidance.
- Management cited market volatility, investment performance relative to competitors, investor flows and sentiment, fee competitiveness, fund-board contract decisions, expenses and regulatory change as factors that could affect results. The company noted ongoing regulatory activity concerning standards of care for financial services firms.
- Two disclosed lawsuits—an ERISA fiduciary-duty case involving the company’s 401(k) plan and a fund shareholder case alleging excessive advisory fees—were described as early-stage. The company said it believed the claims were without merit, was defending them, and could not estimate potential loss or range of loss.
- The company signed a July 9, 2018 letter of intent to sell its 10% Daiwa SB Investments holding, with a third-quarter close expected and a realized gain anticipated. Lease accounting guidance was expected to add right-of-use assets and lease liabilities at adoption in 2019.
- 2018 presentation changes and adoption of revenue-recognition guidance increased reported revenue and expenses by grossing up certain third-party service costs; management said the change did not alter revenue-recognition timing or net operating income.
Investor verification priorities
- Track AUM, net flows and equity-market performance, including whether flows remain positive and fee-rate pressure continues.
- Compare expense growth with revenue growth and assess delivery against the 8%–11% non-GAAP expense outlook.
- Separate core operating trends from non-operating investment results, consolidated investment-product effects, and unusual tax or legal items.
- Review liquidity available for general operations separately from seed-capital and consolidated-product assets, which are not freely available to general creditors.
- Monitor the status and potential financial exposure of the ERISA and advisory-fee litigation, and the expected Daiwa transaction.