T. Rowe Price Group, Inc. — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019. Financial statements are unaudited. The company primarily earns investment advisory fees tied to assets under management (AUM); market movements, investor flows, and asset mix therefore affect results.
Financial and operating performance
- Q2 revenue: Net revenue was $1.395 billion, up 3.7% year over year. Investment advisory fees rose 4.6% to $1.270 billion; administrative, distribution, and servicing fees fell 4.3% to $125.0 million.
- Q2 earnings: Operating income was $615.1 million, up 3.4%; operating margin was 44.1%, versus 44.2%. Net income attributable to T. Rowe Price Group rose 17.5% to $527.5 million, and diluted EPS increased 21.5% to $2.15. Higher non-operating investment gains materially contributed to the net-income increase.
- First-half results: Net revenue was $2.723 billion, up 1.9%; operating income was $1.148 billion, down 2.6%; operating margin was 42.2%, versus 44.1%. Net income attributable to the company rose 15.2% to $1.040 billion, and diluted EPS rose 19.2% to $4.23.
- Adjusted non-GAAP results: Q2 operating expenses rose 2.6% to $764.6 million; diluted EPS was $2.03, up 8.6%. First-half operating expenses rose 2.3% to $1.521 billion; diluted EPS was $3.90, up 8.0%. These measures exclude specified investment-product, supplemental savings plan, and other items; they are not GAAP measures.
- AUM and flows: Period-end AUM was $1.125 trillion, up $80.9 billion, or 7.7%, from June 30, 2018, and up $162.7 billion from year-end 2018. Q2 net inflows were $2.5 billion; first-half inflows were $7.9 billion. First-half market appreciation and income added $154.7 billion. Average Q2 AUM increased 6.1% to $1.100 trillion, while the annualized effective advisory fee rate declined to 46.3 basis points from 47.0 basis points.
- Cash flow and capital returns: First-half operating cash flow was $948.8 million, versus $929.3 million a year earlier. Investing activities used $29.1 million; financing activities used $501.5 million. The company paid $367.8 million in dividends and repurchased $402.8 million of shares in the cash flow statement.
- Balance sheet and liquidity: At June 30, cash and cash equivalents were $1.802 billion, investments were $2.575 billion, total assets were $8.912 billion, and total liabilities were $1.321 billion. The company reported no debt. Management reported $5.196 billion in cash and investments in T. Rowe Price products, including seed-capital and savings-plan hedge investments; consolidated investment-product assets are not available for general operations or creditors.
Material changes and management commentary
- Revenue growth reflected higher average AUM, partly offset by a lower effective fee rate and lower distribution-related fees. Management attributed fee-rate pressure to transfers into lower-fee vehicles or share classes and, to a lesser extent, prior fee reductions.
- GAAP operating expenses increased 4.0% in Q2 and 5.4% in the first half, driven mainly by compensation, annual bonus accruals, supplemental savings plan expense, and strategic investment. Technology, occupancy, and facility costs also increased.
- Non-operating income rose to $124.5 million in Q2 and $327.3 million in the first half, reflecting market-related investment gains, including gains in consolidated investment products. These results can fluctuate with markets.
- Management cited the persistent shift toward passive investing as a challenge to new client inflows, while continuing to invest in investment talent, products, technology, and global distribution. It reported that 72% of U.S. mutual funds outperformed their Morningstar median over one year and 78% over ten years; past performance is not a guarantee of future results.
Outlook, risks, and contingencies
- Management expected 2019 non-GAAP operating expense growth of 4%–7%, reflecting business investment, cost optimization, and phased adoption of third-party investment research costs. It expected 2020 expenses to include a full year of those research costs. Planned 2019 capital expenditures were about $200 million, roughly two-thirds for technology.
- Management estimated a 2019 GAAP effective tax rate of 23.5%–25.5% and a non-GAAP rate of 24%–26%. Rates may vary with stock-based compensation tax benefits, investment results, and non-controlling interests.
- Key business risks include market declines or changes in AUM mix, net outflows, relative investment performance, fee pressure, competition from passive products, operating and technology costs, and regulatory or legal changes. Management stated that future revenue and results depend substantially on AUM value and composition.
- Two lawsuits remained in discovery: an ERISA fiduciary-duty and prohibited-transaction class action concerning the company’s 401(k) plan, and a fund shareholder complaint alleging excessive advisory fees. The company said it considers the claims without merit and is defending them; it could not estimate possible losses or outcomes.
- The company adopted lease accounting in 2019, recognizing $154.9 million of operating lease liabilities at June 30. Adoption did not materially affect operating results. The filing reported no material change in previously disclosed risk factors or market-risk exposure.
Important facts for investors to verify
- Whether AUM growth and net inflows persist, particularly amid the stated long-term shift toward passive investing.
- Whether fee-rate pressure continues as clients move to lower-fee products and share classes.
- How much reported earnings growth reflects recurring advisory operations versus market-sensitive investment gains and supplemental savings plan effects.
- Progress against the 2019 expense-growth outlook, the 2020 research-cost step-up, and planned technology capital expenditures.
- Developments in the two lawsuits, for which the filing provides no estimable loss range.
- The liquidity composition: reported cash and total product investments include assets with different availability for general corporate use.