T. Rowe Price Group, Inc. — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016. The filing is unaudited interim financial information; KPMG conducted a review, not an audit.
Business context and financial performance
T. Rowe Price earns most revenue from investment advisory services, with fees largely dependent on assets under management (AUM), market movements, and the mix of client assets. AUM was $776.6 billion at June 30, up $13.5 billion from year-end, primarily reflecting market appreciation and income; first-half net client flows after transfers were positive $2.4 billion.
- Q2 revenue: Net revenue was $1.045 billion, down 2.6% from $1.072 billion a year earlier. Advisory fees fell 2.3% to $920.6 million. Average AUM decreased 1.4% to $772.7 billion; the average annualized advisory fee rate eased to 47.9 basis points from 48.2.
- Q2 earnings: Operating income was $283.5 million, down 44.2%; operating margin was 27.1%, versus 47.4%. Net income attributable to T. Rowe Price was $195.3 million, down 41.4%; diluted EPS was $0.76, down from $1.24.
- First half: Net revenue was $2.039 billion, down 2.9%; operating income was $694.4 million, down 29.5%. Net income attributable to the company was $490.5 million, down 23.7%, and diluted EPS was $1.91 versus $2.39. Operating margin was 34.1%, versus 46.9%.
- Non-operating income and taxes: Q2 non-operating income rose to $41.5 million from $33.0 million; first-half non-operating income was $126.6 million versus $59.8 million, including higher investment gains and income from newly consolidated portfolios. The estimated full-year 2016 effective tax rate was 38.3%.
- Cash flow and capital: Reported first-half operating cash flow was negative $31.5 million, affected substantially by consolidated investment portfolios’ trading activity. Management reported $644.9 million of operating cash flow attributable to Price Group. Investing cash flow was $162.0 million and financing cash flow was $101.1 million, both on the consolidated reported basis. The company remained debt-free. It reported $1.275 billion of balance-sheet cash and described cash and discretionary sponsored-portfolio investment holdings of $2.1 billion as available liquidity; sponsored-portfolio assets are not directly available for general operations.
- Balance sheet and shareholder returns: Total assets were $6.582 billion, versus $5.107 billion at year-end; the increase principally reflects consolidation of sponsored portfolios. Total liabilities were $610.4 million, and redeemable non-controlling interests were $1.110 billion. First-half share repurchases were $244.0 million; dividends declared were $1.08 per share.
Material changes, outlook, and risks
- Dell appraisal-rights matter: The company recorded a one-time $166.2 million operating charge in Q2 to compensate certain clients after a court ruling denied appraisal rights because voting instructions were submitted incorrectly. The charge reduced net income by $100.7 million, or $0.39 per diluted share; $164.4 million was paid in June.
- Accounting consolidation: Adoption of new consolidation guidance on January 1, 2016 brought additional sponsored portfolios onto the balance sheet and income statement, including $1.6 billion of assets and $672.7 million of non-controlling interests at adoption. This materially affects year-over-year balance-sheet and cash-flow comparisons. Consolidated portfolio assets are generally unavailable to company creditors or for general corporate use.
- Expenses and investment: Management expects 2017 operating expense growth to exceed 2016 growth as it increases spending on investment talent, capabilities, technology, and global distribution. 2016 property and equipment spending was expected to be up to $180 million, about two-thirds for technology. Money-market fee waivers were expected to continue through the remainder of 2016.
- Operating environment: Management cited market volatility, AUM and fee-rate sensitivity, competition, and ongoing investment spending. Brexit’s operational effects remained uncertain; the company said it was preparing for multiple scenarios. Regulatory changes—including fiduciary, money-market, derivatives, and European MiFID II requirements—could raise costs or affect products and distribution.
- Legal matters: A Section 36(b) lawsuit alleges excessive advisory fees for certain funds and seeks fee recovery or other relief. The company considers the claims without merit and intends to defend them. Management said other ordinary-course claims were unlikely to have a material adverse effect.
Important facts for investors to verify
- Whether AUM, client flows, and advisory fee rates stabilize or continue to pressure revenue.
- The underlying earnings trend after excluding the $166.2 million Dell-related charge and considering the effects of portfolio consolidation.
- How planned strategic spending affects expense growth, margins, and returns on investment.
- The cash-flow reconciliation between Price Group’s operating cash flow and the consolidated reported figure, and the distinction between corporate liquidity and portfolio assets.
- Developments in the fee litigation, Brexit, and regulatory changes, and any resulting financial or operational effects.