T. Rowe Price Group, Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; comparisons are with Q1 2018 unless noted. T. Rowe Price primarily earns investment advisory fees, which depend on assets under management (AUM) and market levels.
Financial and operating performance
- Revenue: Net revenue was $1.327 billion, essentially flat year over year. Investment advisory fees rose 0.4% to $1.194 billion; administrative, distribution, and servicing fees declined 4.1% to $133.1 million.
- Expenses and margins: GAAP operating expenses rose 6.8% to $794.8 million, while operating income fell 8.8% to $532.5 million. GAAP operating margin was 40.1%, down from 44.0%. Non-GAAP operating expenses increased 2.1% to $756.6 million.
- Profit and EPS: Net income attributable to T. Rowe Price was $512.6 million, up 13.0%; diluted EPS increased 18.1% to $2.09. Adjusted non-GAAP net income was $460.6 million and adjusted diluted EPS was $1.87, up 3.4% and 7.5%, respectively.
- Non-operating items: Non-operating income was $202.8 million versus $16.1 million, including $100.1 million of net investment gains and $101.9 million of gains from consolidated investment products. These market-sensitive items materially lifted reported pretax income.
- AUM and flows: Ending AUM was $1.082 trillion, up from $962.3 billion at year-end 2018 and $1.014 trillion a year earlier. Q1 net inflows were $5.4 billion; market appreciation and income contributed $113.7 billion. Average AUM rose 1.8% year over year to $1.044 trillion. The average annualized advisory fee rate declined to 46.4 basis points from 47.0 basis points.
- Cash flow: Net cash from operating activities was $578.7 million versus $521.0 million. Cash used in investing was $33.8 million versus $519.8 million, largely reflecting the prior-year repositioning of $500 million of cash into T. Rowe Price funds. Cash used in financing was $306.0 million, including $231.0 million of share repurchases and $184.6 million of dividends paid.
- Balance sheet and liquidity: Cash and cash equivalents were $1.657 billion at March 31, compared with $1.425 billion at December 31. The company reported no debt and stated it had ample liquidity. Cash and investments in T. Rowe Price products totaled $4.923 billion, though consolidated investment-product assets are not available for general operations or to general creditors. Total assets were $8.459 billion and total liabilities were $1.261 billion.
Material changes and management commentary
- Advisory revenue growth was modest: U.S. mutual fund advisory fees declined 2.0%, while fees from subadvised, separate-account, and other products rose 6.2%. Management attributed fee-rate pressure to transfers into lower-fee vehicles or share classes and prior-year fee reductions.
- Higher compensation costs—up 11.4%—were the principal driver of GAAP expense growth. Management cited a $34.2 million increase in market-related supplemental savings plan expense, higher salaries and benefits, and a larger average staff. Related hedge investment gains partly offset the savings-plan impact in non-operating income.
- Management cited persistent growth in passive investing as a headwind to new client inflows, while continuing to invest in investment talent, new capabilities, technology, and global distribution. Q1 markets rebounded strongly, contributing substantially to AUM growth and investment gains.
- Operating lease assets and liabilities were recognized in Q1 under the newly adopted lease standard; adoption did not materially affect results of operations.
Outlook, risks, and contingencies
- Management expected 2019 non-GAAP operating expenses to grow 4%–7%, reflecting business investment, cost optimization, and phased adoption of third-party investment research costs. It expected those research costs to be fully included in operating expenses in 2020.
- Management estimated a 2019 GAAP effective tax rate of 23.5%–26.5% and a non-GAAP rate of 24%–26%. It anticipated approximately $200 million of 2019 capital expenditures, about two-thirds for technology.
- Results remain sensitive to market levels, AUM composition and flows, investment performance, fee rates, competition, client retention, expenses, and regulatory or tax changes. The filing reports no material change in the risk factors previously disclosed in the 2018 Form 10-K.
- Two lawsuits remain pending: an ERISA fiduciary-duty and prohibited-transaction class-action matter relating to the company’s 401(k) plan, and a Section 36(b) action alleging excessive advisory fees for certain funds. The company disputes the claims; outcomes and potential losses could not be estimated. Management considered material adverse outcomes from ordinary-course claims remote.
Investor verification priorities
- Assess how much reported earnings growth came from investment gains and consolidated investment products versus recurring advisory operations; compare GAAP with adjusted results.
- Monitor AUM flows, the declining advisory fee rate, and the mix shift toward lower-fee products, particularly in U.S. mutual funds.
- Track compensation and strategic investment spending against the 4%–7% non-GAAP expense-growth outlook and the effect on operating margin.
- Review the pending ERISA and advisory-fee litigation for developments, potential financial exposure, and effects on client or fund relationships.
- Distinguish corporate liquidity from assets held in consolidated investment products, which are not generally available for corporate use.