Morningstar, Inc. 10-Q Summary
Business Context and Reporting Period
Morningstar provides investment research, data, software, ratings, and investment advisory products to financial advisors, asset managers, retirement plan providers, and individual investors. Many offerings are subscription- or license-based and generate recurring revenue. This unaudited Form 10-Q covers the three months ended March 31, 2015, compared with the same period in 2014.
Key Financial Metrics
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Revenue | $189.8 million | $181.2 million | 4.8% |
| Operating income | $44.5 million | $38.5 million | 15.6% |
| Operating margin | 23.5% | 21.3% | Up 2.2 percentage points |
| Net income attributable to Morningstar | $29.7 million | $26.4 million | Approximately 12.5% |
| Diluted EPS | $0.67 | $0.58 | Approximately 15.5% |
| Cash flow from operations | $35.0 million | $11.9 million | Up $23.1 million |
| Free cash flow | $20.6 million | $(8.9) million | Improved $29.5 million |
| Cash, cash equivalents, and investments | $243.2 million | $224.6 million at Dec. 31, 2014 | Up $18.6 million |
Revenue increased despite a $6.5 million unfavorable foreign-currency translation effect. Organic revenue, excluding acquisitions and currency effects, increased 6.6%. Asset-based fees represented approximately 15% of revenue, compared with 12% in the prior-year quarter.
Operating expenses increased 1.8% to $145.3 million, slower than revenue growth. Cost of revenue rose 3.9% to $78.7 million, sales and marketing declined 10.6% to $25.4 million, general and administrative expense was essentially flat at $26.1 million, and depreciation and amortization increased 22.0% to $15.1 million. The effective tax rate declined to 33.3% from 34.1%.
Cash and cash equivalents were $204.6 million at March 31, 2015, supplemented by $38.6 million of investments. The company had $45.0 million outstanding under a $75.0 million revolving credit facility, leaving $30.0 million available. Total liabilities were $364.8 million and total equity was $661.0 million.
Material Changes Versus the Prior Comparable Period
- Revenue growth was led by Morningstar Credit Ratings, Morningstar Direct, Morningstar Managed Portfolios, and Advisor Workstation, including Morningstar Office.
- Morningstar Credit Ratings revenue increased $3.5 million, and Morningstar Direct revenue increased $2.8 million.
- Morningstar Principia revenue declined $1.9 million as subscribers migrated to newer workflow products. Morningstar Data revenue declined $1.0 million, and Investment Advisory revenue declined $0.9 million.
- International revenue declined 4.5% on a reported basis because of currency translation, but increased 8.2% organically. U.S. revenue increased 8.4%.
- Sales and marketing expense benefited from lower sales commissions and travel costs. The prior-year period included higher commission amortization under a changed commission structure and litigation-related legal fees that did not recur.
- Depreciation and amortization increased because of higher capital expenditures, capitalized software development, and amortization of acquisition-related intangible assets.
- Cash flow benefited from higher earnings, deferred revenue growth, and operating working-capital changes. Q1 2014 investing cash flow benefited from $73.7 million of investment maturities and sales, whereas Q1 2015 investing cash flow was $(14.1) million.
- The company paid $8.4 million in dividends and repurchased 32,026 shares for $2.3 million during the quarter. Approximately $171.1 million remained under the $700.0 million repurchase authorization, which expires December 31, 2015.
Guidance, Outlook, Risks, and Unusual Items
The filing does not provide specific full-year revenue, earnings, or margin guidance. Management expects available cash, investments, operating cash generation, and the credit facility to meet operating and cash needs for at least the next 12 months. Capital expenditures are expected to continue in 2015 for hardware, software, internally developed software, and leasehold improvements.
Management expects approximately $16.0 million of intangible amortization for the remainder of 2015 and $17.0 million in 2016, subject to acquisitions, divestitures, useful-life changes, and currency movements.
Key risks include foreign-currency volatility, financial-market and economic downturns, market effects on asset-based fees, technology outages and cybersecurity or personal-information liabilities, regulatory changes affecting advisory and credit-rating activities, competitive and technological pressures, brand and reputation risk, and challenges in international operations. The company does not hedge currency exposure. A 10% adverse currency movement was estimated to reduce revenue by approximately $1.3 million to $2.0 million by currency category and reduce equity by approximately $19.1 million in aggregate across disclosed net currency positions.
The company recorded a $19.8 million foreign-currency translation loss in other comprehensive income, reducing comprehensive income attributable to Morningstar to $10.0 million from $29.0 million. No goodwill impairment was recorded. The company is subject to tax audits and had $11.6 million of gross unrecognized tax benefits at March 31, 2015. Management did not believe existing legal proceedings would have a material adverse effect.
During the quarter, several international operations migrated to a new accounting system. Management reported no known control deficiencies and concluded that disclosure controls were effective. The company is evaluating the impact of the new revenue-recognition standard, effective for it January 1, 2017, but had not selected a transition method or determined the financial statement impact.
Important Facts for Investors to Verify
- Whether reported revenue growth continues after the $6.5 million currency headwind and the nonrecurring $1.7 million prior-year revenue benefit.
- The sustainability of margin expansion given higher headcount, software investment, depreciation, and acquisition-related amortization.
- Foreign-currency effects on revenue, operating income, goodwill, and accumulated other comprehensive income.
- Use and refinancing of the $45.0 million revolving-credit balance and the availability of the remaining $30.0 million.
- Execution and retention trends for Morningstar Direct, Advisor Workstation, Morningstar Managed Portfolios, and the acquired ByAllAccounts and HelloWallet businesses.
- Progress in migrating Principia subscribers and the effect on legacy-product revenue.
- The company’s continued capital-expenditure needs, share repurchases, dividend payments, and resulting free cash flow.
- Potential effects of tax audits, $11.6 million of unrecognized tax benefits, and adoption of the new revenue-recognition standard.