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TROW > SEC Filings for TROW > Form 10-Q on 24-Oct-2012All Recent SEC Filings

Show all filings for PRICE T ROWE GROUP INC

Form 10-Q for PRICE T ROWE GROUP INC


24-Oct-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

GENERAL.

Our revenues and net income are derived primarily from investment advisory services provided to individual and institutional investors in our sponsored mutual funds and other investment portfolios. The other investment portfolios include separately managed accounts, subadvised funds, and other sponsored investment portfolios including common trust funds and mutual funds offered to investors outside the U.S. and through variable annuity life insurance plans. Investment advisory clients domiciled outside the U.S. account for nearly 10% of our assets under management at September 30, 2012.

We manage a broad range of U.S., international and global stock, bond, and money market mutual funds and other investment portfolios, which meet the varied needs and objectives of individual and institutional investors. Investment advisory revenues depend largely on the total value and composition of assets under our management. Accordingly, fluctuations in financial markets and in the composition of assets under management affect our revenues and results of operations.

We remain debt-free with substantial liquidity and resources that allow us to take advantage of attractive growth opportunities, invest in key capabilities including investment professionals and technologies and, most importantly, provide our clients with strong investment management expertise and service both now and in the future.

BACKGROUND.

Most of the equity markets around the globe continued their upward momentum from the end of June posting strong returns for the third quarter of 2012. Against the backdrop of weakening global economic activity, equities were lifted by strong but slowing corporate earnings growth, and pledges by central banks to implement economic stimulus measures. In September, the European Central Bank unveiled a plan to purchase short-term debt of troubled countries that seek formal financial assistance and agree to implement reform. Also, the Federal Reserve announced an open-ended policy of buying agency mortgage-backed securities every month until the labor market outlook improved substantially, and confirmed that it would likely keep the federal funds rate at exceptionally low levels at least through mid-2015.

Results of several major equity market indexes for the three- and nine-month periods ended September 30, 2012 are as follows:

                                                 Three months ended       Nine months ended
Index                                                9/30/2012                9/30/2012
S&P 500 Index                                               6.4 %                   16.4 %
NASDAQ Composite Index (1)                                  6.2 %                   19.6 %
Russell 2000 Index                                          5.3 %                   14.2 %
MSCI EAFE (Europe, Australasia, and
Far East) Index                                             7.0 %                   10.6 %
MSCI Emerging Markets Index                                 7.9 %                   12.3 %

(1) returns exclude dividends

U.S. Bonds produced positive returns in the third quarter of 2012, as Treasury bond yields remained near historic lows. The yield on the benchmark 10-year U.S. Treasury at September 30, 2012, was 1.7%, flat to June 30, 2012, and 24 basis points lower than the rate at the end of 2011. High yielding securities strongly outperformed the investment-grade bond market as bond investors sought riskier assets. Interest rate cuts in some prominent emerging markets, including Brazil and China, helped U.S. dollar-denominated emerging markets bonds generate very strong returns.

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Returns for several major bond market indexes for the three- and nine-month periods ended September 30, 2012 are as follows:

Three months ended Nine months ended Index 9/30/2012 9/30/2012 Barclays U.S. Aggregate Index 1.6 % 4.0 % Credit Suisse High Yield Index 4.3 % 11.2 % Barclays Municipal Bond Index 2.3 % 6.1 % Barclays Global Aggregate
Ex-U.S. Dollar Bond Index 4.4 % 5.2 % JPMorgan Emerging Markets Bond Plus 6.9 % 14.3 %

ASSETS UNDER MANAGEMENT.

Our assets under management (in billions) have changed during 2012 as follows:

                                      Quarter ended      Quarter ended        Quarter ended      First nine months
                                        3/31/2012          6/30/2012            9/30/2012         ended 9/30/2012
Assets under management at beginning
of period                            $       489.5     $       554.8        $       541.7        $         489.5
Net cash flows
Sponsored mutual funds in the U.S.             5.3               6.3                  4.5                   16.1
Other portfolios                               7.1              (1.6 )                (.2 )                  5.3
                                              12.4               4.7                  4.3                   21.4
Market valuation changes and income           52.9             (17.8 )               28.4                   63.5
Change during the period                      65.3             (13.1 )               32.7                   84.9
Assets under management at end of
period                               $       554.8     $       541.7        $       574.4        $         574.4

Assets under management at September 30, 2012, include $419.1 billion in stock and blended asset investment portfolios and $155.3 billion in fixed income investment portfolios. The investment portfolios that we manage consist of $342.9 billion in the T. Rowe Price mutual funds distributed in the U.S. and $231.5 billion in other investment portfolios.

We incur significant expenditures to attract new investment advisory clients and additional investments from our existing clients. These efforts involve costs that generally precede any future revenues that we might recognize from additions to our assets under management.

RESULTS OF OPERATIONS.

Third quarter of 2012 versus third quarter of 2011.

Investment advisory revenues were up 14.4%, or $83.4 million, to $661.4 million in the third quarter of 2012, as average assets under our management increased $67.3 billion to $557.8 billion. The average annualized fee rate earned on our assets under management was 47.2 basis points during the third quarter of 2012, which is unchanged from the annualized fee rate earned during the first half of 2012. We waived $8.9 million in money market advisory fees in the third quarter of 2012, a decrease of $1.8 million from the comparable 2011 quarter, in order to maintain a positive yield for fund investors. These fee waivers represent about 1% of our total investment advisory revenues earned during the third quarter of 2012. We have waived fees from each of our money market mutual funds and trusts, which have combined net assets of $15.0 billion at September 30, 2012. We expect that these fee waivers will continue in the fourth quarter of 2012 and into 2013.

Net revenues increased $90.3 million, or 13.3%, to $769.7 million in the third quarter of 2012. Operating expenses were $410.8 million in the third quarter of 2012, an increase of $26.6 million or 6.9%. Overall, net operating income for the third quarter of 2012 increased $63.7 million to $358.9 million. The increase in our average assets under management and corresponding investment advisory revenues from higher market valuations lifted our operating margin in the third quarter of 2012 to 46.6% compared to 43.5% in the 2011 period. Net income increased $61.8 million to $247.3 million compared with $185.5 million in the third quarter of 2011. Our diluted earnings per share on our common stock increased 32.4% to $.94 from the $.71 earned in

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the third quarter of 2011. The 2012 results include realized gains of $31.2 million, or $.07 per share after income taxes, from the sale of certain of the firm's investments in sponsored mutual funds to seed other sponsored portfolios in support of the firm's distribution efforts outside the U.S.

Revenues

Investment advisory revenues earned from the T. Rowe Price mutual funds distributed in the U.S. were $458.1 million, an increase of $60.3 million, or 15.2%, on higher average assets under management. Average mutual fund assets under management in the third quarter of 2012 were $332.5 billion, an increase of 15.3% from the average in the third quarter of 2011. Mutual fund assets at September 30, 2012 were $342.9 billion, an increase of $21.2 billion from June 30, 2012. Net cash inflows into the mutual funds during the third quarter of 2012 were $4.5 billion, including $2.2 billion into the stock and blended asset funds, $2.1 billion into the bond funds, and $.2 billion into the money market funds. These net cash inflows include $2.1 billion originating in the target-date retirement funds, which in turn invest in a broadly diversified portfolio of other Price funds, and automatically rebalance to maintain their specific asset allocation weightings. Market appreciation and income increased mutual fund assets under management by $16.7 billion during the third quarter of 2012.

Investment advisory revenues earned in the third quarter of 2012 on the other investment portfolios increased $23.1 million compared to the 2011 quarter to $203.3 million, as average assets under management increased $23.1 billion, or 11.4%, to $225.3 billion. Assets under management in these portfolios at September 30, 2012 were $231.5 billion, an increase of $11.5 billion from June 30, 2012. Market appreciation and income of $11.7 billion during the third quarter of 2012 was slightly offset by $.2 billion in net cash outflows. While net cash flows from our institutional channel over the long-term have been strong, they are typically more variable over shorter periods, meaning some individual quarters can be much stronger or weaker than others.

Administrative fee revenues increased $3.1 million to $83.4 million in the third quarter of 2012. The increase is primarily attributable to our mutual fund servicing activities and defined contribution recordkeeping services for the mutual funds and their investors. Changes in administrative fee revenues are generally offset by similar changes in related operating expenses that are incurred to provide services to the funds and their investors.

Distribution and servicing fee revenues earned from 12b-1 plans of the Advisor, R, and variable annuity class shares of our sponsored portfolios increased $3.9 million from the third quarter of 2011 on greater average assets under management in these share classes. The 12b-1 fees earned are offset entirely by the costs paid to third-party intermediaries who source these assets. These costs are reported as distribution and servicing costs on the face of the condensed consolidated income statements.

Operating expenses

Compensation and related costs were $263.8 million in the third quarter of 2012, an increase of $12.2 million, or 4.8%, compared to the third quarter of 2011. The largest part of the increase is attributable to $7.4 million in higher salaries and related benefits, which results from a modest increase in salaries at the beginning of 2012 combined with a 1.4% increase in our average staff size from the third quarter of 2011. The remainder of the change from the third quarter of 2011 is attributable to a modest increase in the interim accrual for our annual variable compensation programs, increased use of temporary personnel, and other employee-related costs. At September 30, 2012, we employed 5,295 associates.

Advertising and promotion expenditures were $17.5 million in the third quarter of 2012 compared to $19.0 million in the 2011 quarter. We currently expect that our advertising and promotion expenditures for the full year 2012 will be similar to 2011 levels. We vary our level of spending based on market conditions and investor demand as well as our efforts to expand our investor base in the U.S. and abroad.

Occupancy and facility costs together with depreciation and amortization expense were $51.6 million in the third quarter of 2012, up $3.9 million compared to the third quarter of 2011. The change includes the added costs incurred to expand our facilities around the world as well as update our technology capabilities, including related maintenance programs, to meet increasing business demands.

Other operating expenses were $53.5 million in the third quarter of 2012, an increase of $8.1 million from the comparable 2011 period. The increase is primarily attributable to $5.4 million in certain third-party servicing costs incurred in the third quarter of 2012 in which the comparable 2011 period costs were reported as reductions of advisory and administrative fee revenues. The remainder of the change from the third quarter of 2011 is attributable to increases in other operating costs to meet increasing business demands.

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Non-operating investment income

Our non-operating investment income, which includes the recognition of investment gains and losses, was up $40.1 million from the third quarter of 2011, including $31.2 million in gains realized from the sale of certain of the firm's investments in sponsored mutual funds to seed other sponsored portfolios in support of the firm's distribution efforts outside the U.S. We also recognized gains from our other investments of $4.0 million in 2012 quarter compared with losses of $1.2 million in the comparable 2011 quarter.

Provision for income taxes

The provision for income taxes as a percentage of pretax income for the third quarter of 2012 is 38.2%, slightly lower than the 38.4% effective tax rate for the first nine months of 2012. We currently estimate our effective tax rate for the full year 2012 will be 38.4%. Our effective income tax rate reflects the relative contribution of pre-tax income generated by our non-U.S. subsidiaries that are subject to tax rates lower than our U.S. rates. Changes in the relative contribution of pre-tax income from U.S. and non-U.S. sources or changes in tax rates in relevant non-U.S. jurisdictions may affect our effective income tax rate and overall net income in the future.

First nine months of 2012 versus first nine months of 2011.

Investment advisory revenues were up 7.6%, or $135.9 million, to about $1.9 billion in the first nine months of 2012, as average assets under our management increased $40.9 billion to $542.2 billion. The average annualized fee rate earned on our assets under management was 47.2 basis points in the first nine months of 2012, down slightly from the 47.3 basis points earned in the full-year 2011. We waived $25.5 million in money market advisory fees in the first nine months of 2012, a decrease of $.5 million from the $26.0 million waived in the 2011 period. The fee waivers in the first nine months of 2012 represent about 1% of our total investment advisory revenues earned during the same period.

Net revenues increased $159.7 million, or 7.7%, to about $2.2 billion. Operating expenses were about $1.2 billion in the first nine months of 2012, an increase of $89.9 million, or 7.9%. Overall, net operating income for the first nine months of 2012 increased $69.8 million to $1.0 billion. Our operating margin in the first nine months of 2012 was 44.9% compared to 45.0% in the 2011 period. Non-operating investment income of $53.9 million for the first nine months of 2012 included $31.2 million, or $.07 per share after income taxes, in gains realized from the sale of certain of the firm's investments in sponsored mutual funds to seed other sponsored portfolios in support of the firm's distribution efforts outside the U.S. Net income, including these realized gains, increased $66.8 million to $651.6 million for the first nine months of 2012, and our diluted earnings per share on our common stock increased 12.7% to $2.48.

Revenues

Investment advisory revenues earned from the T. Rowe Price mutual funds distributed in the U.S. increased 8.4%, or $101.9 million, to $1.3 billion, on higher average mutual fund assets. Average mutual fund assets in the first nine months of 2012 were $321.1 billion, an increase of 9.1% from the average for the comparable 2011 period. Mutual fund assets of $342.9 billion at September 30, 2012, increased $53.5 billion from $289.4 billion at the end of 2011. Net cash inflows were $16.1 billion during the first nine months of 2012, including $10.0 billion into the stock and blended asset funds and $6.8 billion into the bond funds. Our money market funds had net outflows of $.7 billion. Mutual fund net cash flows include $5.5 billion originating in the target-date retirement funds. These mutual fund net inflow amounts are presented net of $4.0 billion that was transferred to the other investment portfolios. These transfers were primarily from our target-date retirement funds to our target-date retirement trusts. Higher market appreciation and income in the first nine months of 2012 increased our mutual fund assets under management by $37.4 billion.

Investment advisory revenues earned on the other investment portfolios for the first nine months of 2012 were $596.1 million, an increase of $34.0 million, or 6.0%, from the $562.1 million earned in the comparable 2011 period. Average assets in these portfolios were $221.1 billion during the first nine months of 2012, up $14.1 billion from the comparable 2011 period. Net inflows of $5.3 billion and market appreciation and income of $26.1 billion increased assets under management in these portfolios by $31.4 billion during the first nine months of 2012 to $231.5 billion at September 30, 2012. Net inflows during the first nine months of 2012 include the $4.0 billion transferred from the mutual funds. Strong net inflows into our sub-advised funds from third-party financial intermediaries were partially offset by net outflows from institutional investors.

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Administrative fee revenues increased $8.1 million to $249.0 million in the first nine months of 2012. The increase is attributable to our mutual fund servicing activities and defined contribution recordkeeping services for the mutual funds and their investors. As noted above, changes in administrative fee revenues are generally offset by similar changes in related operating expenses that are incurred to provide services to the funds and their investors.

Distribution and servicing fee revenues earned from 12b-1 plans of the Advisor, R, and variable annuity class shares of our sponsored portfolios were $70.3 million in the first nine months of 2012, an increase of $15.9 million from the comparable 2011 period. The increase includes $7.0 million recognized on greater average assets under management in these share classes, and $8.9 million earned primarily on R class shares in the first quarter of 2012 for which the comparable fees for the first quarter of 2011 were netted against related distribution and servicing costs. The 12b-1 fees earned are offset entirely by the costs paid to third-party intermediaries who source these assets. These costs are reported as distribution and servicing costs on the face of the condensed consolidated income statements.

Operating expenses

Compensation and related costs were $786.0 million in the first nine months of 2012, an increase of $42.7 million, or 5.7%, compared to the 2011 period. The largest part of the increase is attributable to a $25.6 million increase in salaries and related benefits and an $8.9 million increase in our interim accrual for our annual variable compensation programs. Our average staff size has increased 2.2% from the first nine months of 2011. Higher non-cash stock-based compensation expense, temporary staff expenses, and other employee costs account for the remainder of the increase in compensation and related costs in the 2012 period.

Occupancy and facility costs together with depreciation expense increased $13.3 million, or 9.6%, compared to the first nine months of 2011. The change includes the added costs incurred to expand our facilities around the world as well as update our technology capabilities, including related maintenance programs, to meet increasing business demands.

Other operating expenses were $160.6 million in the first nine months of 2012, an increase of $19.9 million from the comparable 2011 period. The increase is primarily attributable to $15.6 million in certain third-party servicing costs incurred in the first nine months of 2012, in which the comparable 2011 period costs were reported as reductions of advisory and administrative fee revenues. The remainder of the change from the 2011 period is attributable to increases in other operating costs to meet increasing business demands.

Non-operating investment income

Our non-operating investment income, which includes the recognition of investment gains and losses, was up $43.1 million from the first nine months of 2011, including $33.7 million in gains realized from the sale of sponsored mutual fund investments. The increase also includes $5.1 million in higher net gains recognized on our cost-method and trading investments and $3.3 million in higher dividends earned on our money market investments.

CAPITAL RESOURCES AND LIQUIDITY.

Operating activities during the first nine months of 2012 provided cash flows of $861.0 million, a decrease of $79.5 million from the 2011 period, including $91.1 million related to the net purchase of securities held by consolidated sponsored mutual funds to which we provided seed capital during the first half of 2012 and have a controlling interest. Timing differences in the cash settlement of our assets and liabilities decreased our operating cash flows by $65.3 million compared to the first nine months of 2011. These operating cash flow decreases are offset by increases in net income and non-cash expenses for depreciation, amortization, and stock-based compensation. Our interim operating cash flows do not include variable compensation that is accrued throughout the year before being substantially paid out in December.

Net cash used in investing activities totaled $202.2 million in the first nine months of 2012, an increase of $70.3 million from the comparable 2011 period. We made $114.4 million more net investments in our sponsored mutual funds and increased our capital spending by $6.2 million in the first nine months of 2012 compared with the 2011 period. These increases were offset by greater net cash proceeds of $53.4 million in the first nine months of 2012 from the debt securities held by our savings bank subsidiary.

Net cash used in financing activities was $321.7 million in the first nine months of 2012, a decrease of $298.6 million from the comparable 2011 period. During the first nine months of 2011, we expended $326.4 million more in stock repurchases, including the purchase of 6.2 million more shares, than in the first nine months of 2012. This reduction in cash used was partially offset by the change in customer deposits at our savings bank subsidiary during the first nine months of 2012

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compared to the 2011 period as well as a $20.4 million increase in dividends paid. The increase in dividends paid in the first nine months of 2012 is primarily due to the $.03 increase in our quarterly per-share dividend.

Our cash and mutual fund investments at September 30, 2012 were $2.3 billion, and we have no debt. We anticipate property and equipment expenditures for the full year 2012 to be about $100 million and expect to fund them from our cash balances. We generally repurchase shares of our common stock over time to offset the dilution created by our equity-based compensation plans. Given the availability of our financial resources, we do not maintain an available external source of liquidity.

NEW ACCOUNTING STANDARDS.

We have considered all other newly issued accounting guidance that is applicable to our operations and the preparation of our condensed consolidated statements, including that which we have not yet adopted. We do not believe that any such guidance will have a material effect on our financial position or results of operation.

FORWARD-LOOKING INFORMATION.

From time to time, information or statements provided by or on behalf of T. Rowe Price, including those within this report, may contain certain forward-looking information, including information or anticipated information relating to: our revenues, net income and earnings per share on common stock; changes in the amount and composition of our assets under management; our expense levels; our estimated effective income tax rate; and our expectations regarding financial markets, future transactions, investments, capital expenditures, and other market conditions. Readers are cautioned that any forward-looking information provided by or on behalf of T. Rowe Price is not a guarantee of future performance. Actual results may differ materially from those in forward-looking information because of various factors including, but not limited to, those discussed below and in Item 1A, Risk Factors, of our Form 10-K Annual Report for 2011. Further, forward-looking statements speak only as of the date on which they are made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which it is made or to reflect the occurrence of unanticipated events.

Our future revenues and results of operations will fluctuate primarily due to changes in the total value and composition of assets under our management. Such changes result from many factors including, among other things: cash inflows and outflows in the T. Rowe Price mutual funds and other managed investment portfolios; fluctuations in global financial markets that result in appreciation or depreciation of the assets under our management; our introduction of new mutual funds and investment portfolios; and changes in retirement savings trends relative to participant-directed investments and defined contribution plans. The ability to attract and retain investors' assets under our management is dependent on investor sentiment and confidence; the relative investment performance of the Price mutual funds and other managed investment portfolios as compared to competing offerings and market indexes; the ability to maintain our investment management and administrative fees at appropriate levels; competitive conditions in the mutual fund, asset management, and broader financial services sectors; and our level of success in implementing our strategy to expand our business. Our revenues are substantially dependent on fees earned under contracts with the Price funds and could be adversely affected if the independent directors of one or more of the Price funds terminated or significantly altered the terms of the investment management or related administrative services agreements. Non-operating investment income will also fluctuate primarily due to the size of our investments and changes in their market valuations.

Our future results are also dependent upon the level of our expenses, which are subject to fluctuation for the following or other reasons: changes in the level of our advertising expenses in response to market conditions, including our efforts to expand our investment advisory business to investors outside the U.S. and to further penetrate our distribution channels within the U.S.; variations in the level of total compensation expense due to, among other things, bonuses, stock option grants, other incentive awards, changes in our employee count and . . .

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