Morningstar, Inc. 2016 First-Quarter Form 10-Q Summary
Business context and reporting period
Morningstar, Inc. filed an unaudited Form 10-Q for the three months ended March 31, 2016. The company provides investment research, data, software, advisory, workplace solutions, and credit ratings, with a substantial portion of revenue generated through recurring subscriptions and license agreements. Morningstar reports one operating segment.
Key financial metrics
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Revenue | $192.1 million | $189.8 million | 1.2% |
| Operating income | $42.3 million | $44.5 million | (5.0%) |
| Operating margin | 22.0% | 23.5% | (1.5) percentage points |
| Net income attributable to Morningstar | $28.7 million | $29.7 million | Decrease |
| Diluted EPS | $0.67 | $0.67 | Flat |
| Cash provided by operating activities | $11.4 million | $35.0 million | (67.4%) |
| Free cash flow | $(2.1) million | $20.6 million | Decrease of $22.7 million |
- Total operating expense increased 3.1% to $149.8 million. Cost of revenue increased 8.4%, while sales and marketing declined 12.3% and general and administrative expense declined 1.8%.
- Cost of revenue rose to 44.4% of revenue from 41.5%, while total operating expense rose to 78.0% of revenue from 76.5%.
- The effective tax rate was 33.7%, compared with 33.3% in the prior-year quarter.
- Cash, cash equivalents, and investments totaled $226.7 million at March 31, 2016, including $185.2 million of cash and cash equivalents and $41.5 million of investments.
- Short-term debt was $75.0 million. The revolving credit facility was increased from $75.0 million to $100.0 million, leaving $25.0 million available at quarter-end.
- Total liabilities were $402.2 million and total equity was $630.5 million at March 31, 2016.
- The company declared and paid a quarterly dividend of $0.22 per share during the quarter.
Material changes versus the prior comparable period
- Revenue growth was modest because increases in Morningstar Direct and Morningstar Data were partly offset by lower revenue from Morningstar Credit Ratings, investment management, and certain legacy products.
- Foreign currency movements reduced reported revenue by approximately $2.8 million; management reported organic revenue growth of 2.6% after excluding acquisitions and currency effects.
- Morningstar Credit Ratings revenue declined $3.7 million, primarily because commercial mortgage-backed securities issuance remained weak.
- Operating income and margin declined as compensation, production costs, software subscriptions, professional fees, and depreciation increased. Headcount rose approximately 6.7% to 4,000 employees.
- Operating cash flow and free cash flow declined substantially, primarily reflecting the timing of income tax payments and approximately $50.0 million of bonus payments.
- The company repurchased 497,785 shares for $38.8 million during the quarter. Approximately $337.7 million remained available under the $1.0 billion authorization, which expires December 31, 2017.
- Morningstar acquired RequiSight, LLC, doing business as RightPond, on March 31, 2016. The acquisition contributed $2.5 million of net cash outflow and $3.7 million of goodwill additions, including foreign currency translation.
- Key operating trends were mixed: Morningstar Direct licenses increased 13.3%, registered U.S. users increased 4.0%, and Workplace Solutions assets increased 8.7%; U.S. Premium Membership subscriptions declined 2.8% and Morningstar Office licenses declined 2.1%.
Outlook, commentary, risks, contingencies, and unusual items
- Management described the financial-services environment as challenging because of low interest rates, the shift toward passive investing, market volatility, lower industry fund flows, and declining commercial mortgage-backed securities issuance.
- 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.
- Approximately 75% of cash, cash equivalents, and investments was held outside the United States. Management does not expect to repatriate foreign earnings in the foreseeable future.
- Management expects continued 2016 capital expenditures for hardware, software, internally developed software, and office improvements. Estimated intangible-asset amortization for the remainder of 2016 was $12.8 million.
- Principal risks include cybersecurity and protection of personal and portfolio information, regulatory and compliance exposure, reputational risk, technology and service outages, financial-market conditions, foreign operations and currency fluctuations, industry shifts toward passive products, and lower CMBS issuance.
- The company reported no material changes to the risk factors in its 2015 Form 10-K. It also stated that ordinary-course legal proceedings are not expected to have a material adverse effect.
- Approximately $15.6 million of gross unrecognized tax benefits could affect income tax expense if recognized. The company remains subject to tax audits in U.S. and foreign jurisdictions, but the effect of current audits cannot be estimated.
- The company has not hedged its foreign-currency exposure. A 10% adverse currency movement was estimated to reduce equity by approximately $24.9 million across the disclosed currencies.
- The filing states that disclosure controls were effective as of March 31, 2016, with no material changes to internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the increase in recurring products, particularly Morningstar Direct and Morningstar Data, offsets continued weakness in Credit Ratings and investment management.
- Whether operating expense growth and the higher cost-of-revenue ratio normalize, allowing operating margin to recover.
- The sustainability of operating cash flow and free cash flow after the timing-related tax and bonus payments.
- Future borrowing, liquidity, and cash requirements given the $75.0 million outstanding credit-facility balance and planned capital expenditures.
- The integration and financial contribution of the RightPond acquisition.
- Progress under the share-repurchase program and the effect of repurchases on share count, liquidity, and capital allocation.
- Exposure to foreign currency, financial-market volatility, passive-investment trends, and CMBS issuance levels.
- The eventual accounting effects of the pending revenue-recognition and lease-accounting standards; the filing states that the effects had not yet been determined.