TROW

Business Context and Reporting Period

Company: T. Rowe Price Group, Inc.
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Quarter and six months ended June 30, 2005
Business Overview: The Company derives revenues primarily from investment advisory services provided to individual and institutional investors in sponsored mutual funds and other portfolios. Revenues are dependent on the total value and composition of assets under management (AUM).

Key Financial Metrics

Liquidity: Available net liquid assets were $700 million at June 30, 2005. The Company maintains a $300 million undrawn, committed credit facility expiring in June 2007.

Material Changes vs. Prior Period

• Revenue Growth: Net revenues increased 17.4% in Q2 2005 and 17.1% YTD compared to 2004. Investment advisory fees rose 18.7% in Q2, driven by a $36.7 billion increase in average AUM to $238.7 billion.
• Profitability: Net income increased 28% in Q2 and 25% YTD. Net operating income margins improved due to revenue growth outpacing expense increases.
• Expense Increases: Operating expenses rose $26.4 million in Q2 and $53.4 million YTD. The primary driver was compensation and related costs, which increased $17.0 million in Q2 due to higher associate counts (4,261 total), base salary adjustments, and bonus accruals tied to performance.
• Assets Under Management: Total AUM reached a record $244.8 billion, up $8.9 billion in the quarter. Net cash inflows totaled $8.7 billion YTD, with $3.5 billion in Q2.
• Stock Repurchases: The Company repurchased 1.3 million shares for $75.9 million in the first half of 2005. No repurchases occurred in the first half of 2004.

Outlook, Risks, and Unusual Items

• Accounting Change: The Company will adopt FAS 123R (Share-Based Payment) on January 1, 2006, requiring the recognition of stock option-based compensation expense. Pro forma net income for the six months ended June 30, 2005, would have been $178.7 million (vs. reported $197.0 million) if this method had been applied.
• Tax Benefit: A $1.4 million reversal of a valuation allowance for foreign net operating loss carryforwards reduced the effective tax rate to 36.2% in Q2 and 36.5% YTD. The full-year 2005 effective tax rate is expected to be approximately 36.7%.
• Market Risks: Management notes that revenues fluctuate with financial market performance and AUM composition. Risks include market volatility, rising interest rates, and competitive pressures in the asset management sector.
• Legal Proceedings: A class action lawsuit regarding market timing in the International Stock Fund was dismissed in May 2005, with the plaintiff's motion to amend denied in July 2005. Management believes no pending claims will have a material adverse effect.
• Guidance: Advertising and promotion expenditures are expected to be about 15% higher for the full year 2005 compared to 2004. Q3 advertising is expected to decline 15% from Q2, while Q4 is expected to be 10-15% higher than the comparable 2004 period.

Investor Verification Checklist

• AUM Sustainability: Verify the composition of the $8.7 billion in net inflows and the impact of market appreciation vs. cash flows on future fee revenue.
• Compensation Trends: Monitor the trajectory of compensation costs relative to revenue growth, particularly as bonus accruals are tied to anticipated operating results.
• Stock-Based Compensation Impact: Assess the impact of the upcoming FAS 123R adoption on reported net income starting in 2006.
• Share Repurchase Program: Confirm the remaining authorization under the repurchase program ($4.1 million shares remaining as of June 30, 2005) and future buyback activity.
• Effective Tax Rate: Validate the projected 36.7% full-year tax rate against actual quarterly results and potential changes in tax legislation.