Morningstar, Inc. Form 10-Q Summary
Business context and reporting period
Morningstar provides investment research, data, software, advisory, retirement, credit ratings, and related services, primarily through subscriptions and license agreements that generate recurring revenue. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2015, filed July 30, 2015. The company reports one operating segment.
Financial performance and liquidity
| Metric | Three months ended June 30, 2015 | Six months ended June 30, 2015 |
|---|---|---|
| Revenue | $202.1 million, up 6.7% | $391.9 million, up 5.8% |
| Operating income | $49.7 million | $94.3 million |
| Operating margin | 24.6% | 24.1% |
| Net income attributable to Morningstar | $32.2 million | $61.8 million |
| Diluted EPS | $0.72 | $1.39 |
| Cash provided by operating activities | $75.9 million | $110.9 million |
| Free cash flow | $62.7 million | $83.3 million |
- Adjusted operating margin, excluding the prior-year litigation settlement, was 24.6% in the quarter versus 19.1% in the prior-year quarter, and 24.1% for the first six months versus 20.2%.
- At June 30, 2015, cash and cash equivalents were $225.6 million, investments were $33.0 million, and total assets were $1.05 billion.
- Current liabilities were $305.0 million, including $163.1 million of deferred revenue and $35.0 million of short-term debt. The $75.0 million revolving credit facility was renewed in July 2015; the $35.0 million outstanding balance at June 30 was repaid on July 20, leaving full availability.
- Approximately 63% of cash, cash equivalents, and investments was held outside the United States. Management stated that U.S. liquidity and operating cash generation should meet U.S. needs without foreseeable repatriation of foreign earnings.
- First-half capital expenditures were $27.6 million. The company repurchased $27.7 million of common stock and paid $16.9 million of dividends.
Material changes versus the prior comparable period
- Revenue growth was led by Credit Ratings, Retirement Solutions, Morningstar Direct, Advisor Workstation, and Morningstar Data. Principia revenue declined $1.3 million as subscribers migrated to newer workflow products.
- Organic revenue increased 10.3% in the quarter and approximately 8.5% for the first six months, excluding acquisitions and foreign-currency effects. The strong U.S. dollar reduced reported revenue by $7.6 million in the quarter and $14.1 million year to date.
- International reported revenue declined 3.8% in the quarter and 4.2% year to date, while international organic revenue increased 10.6% and 9.3%, respectively.
- Operating results benefited substantially from the nonrecurrence of a $61.0 million litigation settlement recorded in the second quarter of 2014. The prior-year period also included a $5.2 million nontaxable gain related to the acquisition of the remaining HelloWallet ownership interest.
- Sales and marketing expense declined 10.3% in the quarter and 10.5% year to date, while general and administrative expense declined 8.6% and 4.7%, respectively. Depreciation and amortization increased 21.9% in the quarter and 22.0% year to date, primarily from higher software and capital investment.
- Cash from operations increased 38.5% in the quarter and 66.3% year to date. First-half free cash flow increased 132.0%, although the comparison was affected by the prior-year litigation settlement cash payment.
Guidance, outlook, risks, contingencies, and unusual items
- The filing does not provide explicit full-year revenue or earnings guidance. Management expects continued 2015 capital expenditures for hardware, software, internally developed software, and leasehold improvements.
- Remaining 2015 intangible amortization was estimated at $10.8 million, with $17.2 million expected in 2016; these estimates may change with acquisitions, dispositions, useful-life revisions, or currency movements.
- Management described the financial-services environment as mixed, citing regulatory burdens, cautious spending, market volatility, and industry changes including growth in passive investment products.
- Key risks include foreign-exchange exposure, technology outages and cybersecurity or personal-information liabilities, regulatory and compliance actions, fiduciary-duty claims, brand and reputation damage, technological change, financial-market downturns, offshore operational concentration, and trends in the mutual-fund industry. The company does not hedge currency exposure.
- The company is subject to tax audits and had $13.4 million of gross unrecognized tax benefits at June 30, 2015. Management does not believe existing legal proceedings will have a material adverse effect, but outcomes cannot be predicted.
- The $700.0 million share-repurchase authorization expires December 31, 2015. Approximately $145.8 million remained available at June 30, 2015.
- No material changes to previously disclosed risk factors were reported, and management concluded that disclosure controls and procedures were effective.
Important facts for investors to verify
- Separate underlying operating improvement from the large year-over-year benefit of the nonrecurring $61.0 million litigation settlement in 2014.
- Assess the effect of continued U.S.-dollar strength on reported international revenue, operating income, and accumulated comprehensive income.
- Monitor recurring revenue growth, particularly Morningstar Direct, Retirement Solutions, Credit Ratings, Advisor Workstation, and the declining Principia subscriber base.
- Review cash concentration outside the United States, foreign tax and repatriation assumptions, and the status of unrecognized tax benefits and audits.
- Confirm post-quarter repayment of the $35.0 million credit-facility balance and the remaining capacity and expiration of the share-repurchase authorization.
- Evaluate whether increased capitalization of software development and higher depreciation and amortization affect reported operating margins and future cash requirements.