T. Rowe Price Group, Inc. — FY 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018; filed February 13, 2019. This is an annual filing, with fourth-quarter results included.
Business context
T. Rowe Price is an active global investment manager whose results depend primarily on advisory fees tied to assets under management (AUM). It also provides retirement-plan recordkeeping, fund administration, distribution, brokerage, and trust services. The company cited persistent shifts toward passive investing, pricing pressure, changing client needs, and rising regulatory demands.
Key financial metrics
| Metric | FY 2018 | FY 2017 | Change |
|---|---|---|---|
| Net revenue | $5.373 billion | $4.855 billion | +10.7% |
| Net operating income | $2.361 billion | $2.109 billion | +12.0% |
| Operating margin | 44.0% | 43.4% | +0.6 percentage points |
| Net income attributable to T. Rowe Price Group | $1.838 billion | $1.498 billion | +22.7% |
| Diluted EPS | $7.27 | $5.97 | +21.8% |
| Average AUM | $1,036.5 billion | $909.0 billion | +14.0% |
| Year-end AUM | $962.3 billion | $991.1 billion | −2.9% |
| Cash provided by operating activities, consolidated | $1.620 billion | $0.230 billion | Increased |
Advisory fees rose 12.9% to $4.851 billion, driven by higher average AUM. The average annualized advisory fee rate fell to 46.8 basis points from 47.3 basis points, reflecting client transfers to lower-fee products or share classes, selected fee reductions, and asset mix. Operating expenses increased 9.7% to $3.011 billion; non-GAAP expenses rose 8.9% to $3.026 billion. Management attributed increases mainly to strategic investment and higher compensation.
Year-end AUM fell by $28.8 billion: $13.2 billion of net inflows were more than offset by $42.0 billion of market depreciation and losses, including distributions not reinvested. Target-date products attracted $12.0 billion of net inflows and held $230.4 billion in AUM. The S&P 500 fell 4.4% in 2018, while the MSCI EAFE and Emerging Markets indexes declined 13.4% and 14.3%, respectively.
Fourth quarter: Revenue was $1.305 billion, compared with $1.298 billion in Q4 2017. Net income attributable to the Group was $351.9 million versus $347.1 million; diluted EPS was $1.41 versus $1.37. Q4 2018 included a $15.2 million Dell-related expense recovery and a $0.27-per-share realized gain from the sale of the company’s Daiwa SB Investments holding earlier in the year (recognized in Q3, not Q4). Quarterly earnings were also affected by volatile markets and consolidated investment-product losses.
Liquidity and capital: The company reported no debt. At year-end, cash and discretionary investments totaled $3.022 billion; cash and investments in T. Rowe Price products totaled $4.523 billion, including $1.119 billion of seed capital and $381 million invested to hedge the supplemental savings plan. Some product assets are not available for general operations or to general creditors. Stockholders’ equity was $6.124 billion. FY 2018 regular dividends were $2.80 per share, up 22.8%; the company repurchased 10.8 million shares for $1.100 billion. Consolidated operating cash flow includes activity of investment products; cash flow attributable to the Group was $2.178 billion.
Material changes versus the prior period
- Revenue, operating income, and diluted EPS increased, supported by higher average AUM and a lower corporate tax rate.
- Despite positive net flows, ending AUM declined as financial markets weakened late in the year. U.S. mutual fund AUM decreased 6.9%; separately managed accounts, subadvised funds, and other products increased.
- Non-operating income declined to $23.2 million from $396.3 million, primarily reflecting market losses in 2018, including losses in consolidated investment products, versus gains in 2017.
- The effective tax rate fell to 25.8% from 36.9%, principally because the U.S. federal corporate rate was reduced. 2018 results included $20.8 million of U.S. tax-reform-related charges and a $7.9 million Maryland tax-law remeasurement charge.
- Accounting changes adopted in 2018 affected presentation: revenue guidance increased reported revenue and operating expenses by equal amounts in the recast 2017 and 2016 periods, without changing operating income.
Outlook, risks, and unusual items
For 2019, management expected non-GAAP operating expenses to grow 4%–7%, reflecting business investment, cost optimization, and incremental third-party investment research costs. It estimated a 23.5%–26.5% GAAP effective tax rate and planned property and equipment spending of up to $200 million, about 65% for technology. Management emphasized investment talent, new strategies and vehicles, technology, and broader global distribution. It also said market-related circumstances could lead it to adjust expense plans.
Principal risks include market declines and adverse AUM mix, investor outflows, underperformance, fee competition and passive investing, termination or repricing of mutual-fund advisory contracts, dependence on key personnel and intermediaries, operational and cybersecurity events, regulatory change, and foreign-market and currency risks. Brexit, evolving privacy requirements, and the cost of paying for external investment research were also noted.
Two material lawsuits remained unresolved: an ERISA fiduciary-duty and prohibited-transaction class action concerning the company’s 401(k) plan, and a fund-shareholder suit alleging excessive advisory fees. The company disputed both claims; it could not predict outcomes or estimate potential losses. Management considered other ordinary-course claims unlikely to have a material adverse effect. The 2018 Dell appraisal-rights matter generated a $15.2 million operating-expense recovery; the company had previously paid clients and received insurance recoveries.
Important facts for investors to verify
- Whether AUM and net inflows recover after the 2018 market decline, and how much reported flow reflects transfers between the company’s own products.
- Whether lower effective advisory fees and continued passive-investing competition pressure revenue and margins.
- Progress against the 2019 expense-growth outlook, including external research costs and strategic investments.
- The outcomes and potential financial exposure of the ERISA and excessive-fee lawsuits.
- How much of reported liquidity is freely available for corporate use, given seed-capital and consolidated-product restrictions.
- The continuing effects of tax changes, market-sensitive investment income, and accounting presentation changes on comparisons.