Morningstar, Inc. — Form 10-Q Summary
Reporting period: Quarterly and nine-month periods ended September 30, 2015. Financial statements are unaudited and prepared under U.S. GAAP. Morningstar reports one operating segment and generates substantial recurring revenue through subscriptions and license agreements.
Financial Performance and Liquidity
| Metric | Q3 2015 | Q3 2014 | 9M 2015 | 9M 2014 |
|---|---|---|---|---|
| Revenue | $195.3 million | $193.1 million | $587.2 million | $563.7 million |
| Operating income | $46.2 million | $45.3 million | $140.5 million | $59.0 million |
| Operating margin | 23.7% | 23.4% | 23.9% | 10.5% |
| Net income attributable to Morningstar | $33.5 million | $30.2 million | $95.3 million | $46.8 million |
| Diluted EPS | $0.76 | $0.67 | $2.15 | $1.04 |
| Cash flow from operations | $75.6 million | $8.6 million | $186.5 million | $75.3 million |
| Free cash flow | $63.3 million | $(3.4) million | $146.6 million | $32.5 million |
- Q3 revenue increased 1.1%; nine-month revenue increased 4.2%. Management stated that foreign currency translation reduced revenue by $7.3 million in Q3 and $21.4 million in the first nine months.
- Organic revenue, excluding acquisitions and currency effects, increased 4.9% in Q3 and 7.3% for the nine-month period.
- Q3 operating income increased 2.2%. Nine-month operating income increased 138.2%, largely because the prior-year period included a $61.0 million litigation settlement.
- Excluding the litigation settlement, nine-month 2014 adjusted operating income was $120.0 million and adjusted operating margin was 21.3%, compared with 2015 operating income of $140.5 million and a 23.9% margin.
- Q3 effective tax rate was 30.4%, versus 33.4% in Q3 2014. The nine-month rate was 33.6%, versus 30.1% in the prior-year period.
- Cash, cash equivalents, and investments totaled $263.0 million at September 30, 2015, including $223.7 million of cash and cash equivalents and $39.3 million of investments.
- The company had no short-term debt outstanding at September 30, 2015 and had full availability under its renewed $75.0 million revolving credit facility. It repaid $35.0 million of facility borrowings in July.
- Capital expenditures were $39.9 million for the first nine months. The company capitalized $16.4 million of software development costs during the period.
- Quarterly dividends were $0.19 per share; $25.3 million of dividends were paid during the first nine months.
Material Changes Versus the Prior Comparable Period
- Revenue growth was supported by Retirement Solutions, Morningstar Direct, Morningstar Data, and Advisor Workstation. Retirement Solutions revenue increased 14.9% in Q3 and 15.9% for the nine-month period; Morningstar Direct revenue increased 7.6% and 10.3%, respectively.
- Credit Ratings revenue declined $0.9 million in Q3 amid market volatility. Principia and certain legacy software products declined $2.4 million as subscribers migrated to newer workflow solutions.
- International reported revenue declined 3.3% in Q3 and 3.9% for the first nine months because of currency translation, while international organic revenue increased 10.8% and 9.8%, respectively.
- Sales and marketing expense declined 12.8% in Q3 and 11.2% for the nine-month period, primarily due to lower sales commission expense. General and administrative expense also declined.
- Depreciation and amortization increased 12.6% in Q3 and 18.6% for the nine-month period, primarily reflecting higher depreciation from capitalized software and other technology investments.
- Operating cash flow and free cash flow improved substantially, aided by the absence of the $61.0 million litigation settlement payment made in the prior-year period and favorable changes in working capital.
- Shares outstanding declined modestly as the company repurchased 396,431 shares for $30.1 million during the first nine months. Approximately $143.4 million remained available under the $700.0 million repurchase authorization, which expires December 31, 2015.
Outlook, Commentary, Risks, and Unusual Items
- Management stated that available cash, investments, operating cash flow, and the credit facility should be sufficient to meet operating and cash needs for at least the next 12 months. No formal revenue or earnings guidance was provided in the filing.
- Management expects continued 2015 capital expenditures for computer hardware and software, internally developed software, and leasehold improvements.
- Estimated intangible amortization expense was $5.4 million for the remainder of 2015 and $17.3 million for 2016, subject to acquisitions, dispositions, useful-life changes, and currency movements.
- The financial services environment was described as mixed. Market volatility, fee pressure, regulatory burdens, mutual-fund industry trends, and the increasing popularity of passive investment products may affect demand and asset-based fees.
- Approximately 15% of revenue came from asset-based fees in Q3 and the first nine months, up from approximately 13% in the comparable 2014 periods. Market declines could therefore affect revenue.
- Key risks include reputational or fiduciary liability, cybersecurity and protection of personal information, regulatory compliance, technology failures, dependence on offshore operations in China and India, foreign currency exposure, and financial-market downturns.
- The company does not hedge currency risk with derivatives. A 10% adverse currency movement would have an estimated negative effect on equity of approximately $24.3 million in aggregate across the currencies presented.
- The company reported no material adverse effect expected from ordinary-course legal proceedings and no material changes to the risk factors in its 2014 Form 10-K.
- No goodwill impairment was recorded in the first nine months of 2015 or 2014; annual impairment reviews occur in the fourth quarter.
Investor Verification Priorities
- Verify the sustainability of organic revenue growth after separating currency benefits, acquisitions, and product migrations.
- Assess the comparability of nine-month profit and cash-flow growth given the $61.0 million prior-year litigation settlement and related payment.
- Monitor international revenue, foreign currency exposure, and the absence of currency hedging.
- Evaluate whether higher depreciation, software investment, and ongoing amortization could pressure future margins and free cash flow.
- Review the renewal, covenants, and future use of the $75.0 million revolving credit facility, despite no debt outstanding at quarter-end.
- Track asset-based fee revenue and assets under advisement, particularly during periods of market volatility and fund outflows.
- Confirm the status of the $700.0 million share repurchase authorization, which was scheduled to expire on December 31, 2015.
- Review unrecognized tax benefits of $14.2 million and ongoing domestic and foreign tax audits, as well as the potential impact of future tax-rate changes.