Morningstar, Inc. 2015 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2015. The filing also provides unaudited fourth-quarter 2015 data. Morningstar is a global provider of investment data, research, software, ratings, advisory services, and investment management solutions serving advisors, asset managers, retirement organizations, and individual investors across 27 countries.
Business Context and Key Developments
- Core offerings include Morningstar Data, Advisor Workstation, Morningstar Direct, Workplace Solutions, Morningstar.com, Investment Advisory, credit ratings, research, and indexes.
- Strategy centers on leveraging proprietary data and research, expanding Morningstar Direct as the flagship cloud-based platform, and growing investment management solutions.
- Morningstar acquired Total Rebalance Expert in November 2015, adding automated, tax-efficient portfolio rebalancing capabilities for advisors.
- Morningstar began rolling out next-generation versions of Morningstar Direct, Morningstar Retirement Manager, and Morningstar.com.
- As of year-end, Morningstar reported approximately 3,930 employees, 11,428 Morningstar Direct licenses, $176.8 billion of average assets under management and advisement, and approximately $12.9 billion managed through Morningstar Managed Portfolios.
Financial Results and Key Metrics
| Metric | 2015 | 2014 | Change |
|---|---|---|---|
| Revenue | $788.8 million | $760.1 million | 3.8% |
| Operating income | $190.6 million | $105.6 million | 80.5% |
| Operating margin | 24.2% | 13.9% | +10.3 percentage points |
| Net income attributable to Morningstar | $132.6 million | $78.3 million | Up materially |
| Diluted earnings per share | $3.00 | $1.74 | Up materially |
| Cash provided by operating activities | $238.9 million | $132.2 million | 80.7% |
| Capital expenditures | $57.3 million | $58.3 million | (1.7%) |
| Free cash flow | $181.6 million | $73.9 million | 145.7% |
| Cash, cash equivalents, and investments | $248.6 million | $224.6 million | Up $24.0 million |
Margins and earnings: Operating expenses declined 8.6% to $598.2 million. The improvement primarily reflects the absence of the $61.0 million Business Logic litigation settlement recorded in 2014, favorable foreign-currency translation effects, lower commission expense, and lower legal fees. Adjusted operating income, excluding the 2014 settlement, increased 14.4% from $166.6 million to $190.6 million, while adjusted operating margin increased from 21.9% to 24.2%.
Revenue mix and growth: Asset-based fee revenue increased to $116.9 million from $94.1 million and represented approximately 14.8% of consolidated revenue. Organic revenue, excluding acquisitions and foreign-currency effects, increased 6.8% to $811.6 million. Currency translation reduced reported revenue by approximately $26.9 million.
- Morningstar Data revenue: $144.5 million, up 3.6%.
- Advisor Workstation revenue: $106.3 million, up 4.6%.
- Morningstar Direct revenue: $101.7 million, up 10.8%.
- Workplace Solutions revenue: $66.6 million, up 16.3%.
- Morningstar.com revenue: $59.9 million, up 3.0%.
Liquidity and debt: Morningstar had $207.1 million of cash and cash equivalents and $41.5 million of investments at year-end. It had $35.0 million outstanding under a $75.0 million revolving credit facility at LIBOR plus 100 basis points, leaving $40.0 million of availability. Management stated that cash, investments, operating cash flow, and the credit facility should be sufficient for operating and cash needs for at least the next 12 months.
Capital allocation: Morningstar repurchased approximately 1.2 million shares for $97.0 million during 2015 and had repurchased 9.4 million shares for $623.5 million cumulatively under its program. Approximately $376.5 million remained authorized for repurchases at year-end. Dividends paid totaled $33.7 million, and management expected a regular quarterly dividend of $0.22 per share in 2016, subject to board approval.
Fourth-Quarter 2015 Snapshot
| Metric | Q4 2015 | Q4 2014 |
|---|---|---|
| Revenue | $201.6 million | $196.4 million |
| Operating income | $50.1 million | $46.6 million |
| Net income attributable to Morningstar | $37.3 million | $31.5 million |
| Basic earnings per share | $0.85 | $0.71 |
Material Changes Versus the Prior Comparable Period
- Reported revenue growth slowed to 3.8% from 8.9% in 2014, mainly because of foreign-currency pressure. Excluding currency and acquisitions, organic growth was 6.8%.
- Operating income and free cash flow rebounded sharply because the $61.0 million 2014 litigation settlement did not recur.
- Morningstar Direct and Workplace Solutions were the principal growth contributors, while legacy Principia products and Enterprise Components declined.
- Contract-based renewal rates improved to approximately 99% from 95%; subscription retention declined to approximately 67% from 69%.
- International revenue declined 2.7% on a reported basis to $203.7 million, but increased 10.2% organically excluding currency and acquisitions.
- Investment Advisory assets under advisement declined 4.0% to $77.8 billion, while Workplace Solutions assets under management and advisement increased 16.8% to $89.7 billion.
- Shares outstanding declined as a result of continued repurchases; year-end outstanding shares were 43.4 million compared with 44.3 million at the end of 2014.
Outlook, Commentary, Risks, and Unusual Items
Management does not provide public financial forecasts or earnings guidance. The company intends to continue investing in cloud-based platforms, internally developed software, technology, credit research, and investment management solutions. It expected 2016 capital expenditures to remain focused on hardware, software, internally developed software, and office facilities.
- Global market volatility increased during the second half of 2015. Through February 25, 2016, Morningstar’s U.S. Market Index was down 4.8%, creating potential pressure on asset-based fees, client spending, and investment activity.
- Commercial mortgage-backed securities issuance weakened during the second half of 2015 and remained weak in early 2016, potentially affecting Morningstar Credit Ratings revenue.
- Approximately 15% of 2015 revenue came from asset-based fees, making results sensitive to market levels, asset flows, and redemptions.
- Actively managed mutual funds experienced substantial net outflows in 2015 while passive products received strong inflows, creating a structural risk for fund-related data, software, and research demand.
- Key operational risks include cybersecurity and privacy breaches, technology or database outages, reliance on offshore data and development operations in China and India, foreign-currency exposure, and intellectual-property protection.
- Investment advisory and retirement businesses face fiduciary, ERISA, broker-dealer, credit-rating, and other regulatory risks. The company reported approximately $180 billion of assets supported by investment advisory and management services and acknowledged that potential fiduciary liabilities cannot be quantified precisely.
- The company had $121.6 million of non-cancelable operating lease commitments, $9.9 million of long-term financing commitments, and $35.2 million of scheduled 2016 credit-facility payments, including estimated interest and fees.
- Morningstar adopted accounting standards relating to measurement-period adjustments and deferred-tax classification early in the fourth quarter; the filing states that neither adoption had a material effect. The new revenue-recognition standard is effective January 1, 2018, and its impact and transition method had not yet been determined.
- KPMG issued unqualified opinions on the consolidated financial statements and the effectiveness of internal control over financial reporting.
Most Important Facts for Investors to Verify
- Whether reported revenue growth can remain positive after separating organic growth from foreign-currency benefits or headwinds and acquisition contributions.
- Whether operating margins remain near 2015 levels after the comparison benefit from the nonrecurring 2014 litigation settlement is fully removed.
- Trends in asset-based fee revenue, assets under management and advisement, market levels, and client inflows or redemptions.
- Renewal and retention rates, particularly the decline in subscription retention and the growth trajectory of Morningstar Direct and Workplace Solutions.
- Commercial mortgage-backed securities issuance and its effect on Morningstar Credit Ratings.
- Cash deployment among share repurchases, dividends, acquisitions, capital expenditures, and repayment or renewal of the revolving credit facility.
- Potential effects of fiduciary regulation, privacy or cybersecurity incidents, litigation, tax audits, and other regulatory contingencies.
- The future accounting and disclosure effects of the revenue-recognition standard effective in 2018.