T. Rowe Price Group, Inc. — Third-Quarter 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. The company primarily earns investment advisory fees, which depend on the value and composition of assets under management (AUM). All amounts below are U.S. dollars.
Financial performance and liquidity
| Metric | Q3 2017 | Q3 2016 | Change |
|---|---|---|---|
| Net revenue | $1,221.7 million | $1,092.9 million | +11.8% |
| Operating expenses | $673.2 million | $617.2 million | +9.1% |
| Net operating income | $548.5 million | $475.7 million | +15.3% |
| Net income attributable to T. Rowe Price | $390.9 million | $327.8 million | +19.2% |
| Diluted EPS | $1.56 | $1.28 | +21.9% |
Q3 operating margin was 44.9%, compared with 43.5%. Average AUM increased 15.4% to $927.4 billion; quarter-end AUM was $947.9 billion, up $137.1 billion from December 31, 2016. Net inflows were $5.9 billion in Q3 and $10.3 billion for the first nine months. The average annualized advisory fee rate declined to 46.9 basis points from 48.0 basis points.
For the first nine months, net revenue rose 12.0% to $3,506.9 million. GAAP net income attributable to the company was $1,150.7 million, up 37.8%, and diluted EPS was $4.60 versus $3.25. Adjusted non-GAAP net income was $977.2 million, up 15.5%, and adjusted diluted EPS was $3.91 versus $3.29. The prior-year comparison includes the Dell-related charge.
Reported operating cash flow for the nine months was $352.8 million, versus $268.2 million. This consolidated figure includes cash movements of sponsored investment portfolios; management reports $1,462.4 million of operating cash flow attributable to T. Rowe Price Group, compared with $1,235.3 million in 2016. Cash and cash equivalents were $1,869.4 million at September 30, 2017, versus $1,204.9 million at year-end 2016. The company reported no debt and total liabilities of $897.8 million. Cash and sponsored investment holdings totaled $4,065.3 million, but certain seed investments are not directly available for general operations.
For the first nine months, the company repurchased $456.7 million of stock and paid $420.8 million in dividends. The quarterly dividend was raised 5.6% in March 2017 to $0.57 per share.
Material changes and unusual items
- AUM growth and favorable markets supported higher advisory revenue, while net flows were positive overall. Higher market valuations also increased the proportion of assets in lower-fee categories, and prior fee reductions contributed to a lower effective fee rate.
- Operating expenses rose with higher compensation, staffing, technology and professional-services costs. Headcount was 6,796 at September 30, up 467 from year-end 2016.
- In Q1 2017, the company recorded $50 million of insurance recoveries related to the 2016 Dell appraisal-rights matter. The original $166.2 million charge and subsequent recoveries materially affect year-over-year GAAP comparisons. The company had received $150 million in total insurance proceeds by June 30, 2017.
- Q3 non-operating income fell to $67.3 million from $88.3 million, primarily reflecting lower income from consolidated sponsored portfolios. For the nine months, non-operating income increased to $294.3 million from $214.9 million, including investment disposition gains and gains associated with the supplemental savings plan hedge.
Outlook, risks and contingencies
- Management expected 2017 non-GAAP operating expenses to grow about 11% versus 2016, up from prior guidance of about 10%, mainly due to higher-than-anticipated market-related variable compensation. It expected 2017 capital expenditures of up to $200 million, about two-thirds for technology, and advertising costs up to 10% above 2016.
- Management cited continued investment in talent, technology, products and global distribution. Revenue and results remain sensitive to financial-market movements, asset flows, investment performance, fee levels and competition.
- The company estimated a 35.9% full-year 2017 effective tax rate; tax rates may vary due to stock-option tax benefits, portfolio consolidation and the geographic mix of income.
- Two early-stage lawsuits remain unresolved: an ERISA fiduciary-duty and prohibited-transaction class-action claim involving the company’s 401(k) plan, and a mutual-fund advisory-fee case alleging excessive fees. The company disputes both and cannot estimate potential loss. Appeals concerning the Dell appraisal valuation could require adjustments under client and insurer settlement arrangements.
- Management warned that evolving regulation may raise compliance costs or affect products and operations. It expected MiFID II implementation to increase costs, though not materially, and decided that its UK investment manager would pay for third-party investment research.
Most important facts for investors to verify
- Whether AUM growth and net inflows continue, and how market performance affects fee revenue.
- Whether fee-rate pressure and expense growth remain consistent with management’s 2017 outlook.
- How much reported cash and investment holdings are available for corporate use, given seed-capital and consolidated-fund restrictions.
- The effect of Dell-related recoveries, investment gains and sponsored-portfolio consolidation on comparisons with core operating results.
- Developments in the ERISA and mutual-fund fee litigation, and any related potential financial exposure.