Morningstar, Inc. 2017 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2017. The filing was filed March 1, 2018. Although the request references 2017 Q4, this is an annual filing; selected fourth-quarter results are included below.
Business context
Morningstar provides independent investment data, research, ratings, software, investment management, retirement advice, credit ratings, indexes, and private-market information through PitchBook. The company serves individual investors, financial advisors, asset managers, retirement plan providers and sponsors, and institutional investors globally. It operates in 27 countries and reports one operating segment.
- Approximately 4,920 employees at year-end, up from 4,550 in 2016.
- Morningstar Direct licenses increased 11.1% to 13,884.
- PitchBook licenses increased 43.0% to 13,908; PitchBook was consolidated for the full year in 2017 versus one month in 2016.
- Assets under management and advisement averaged approximately $207.9 billion, up 7.8%.
Financial performance
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Revenue | $911.7 million | $798.6 million | 14.2% |
| Operating income | $169.8 million | $180.8 million | (6.0%) |
| Operating margin | 18.6% | 22.6% | (4.0) percentage points |
| Net income attributable to Morningstar | $136.9 million | $161.0 million | (15.0%) |
| Diluted EPS | $3.18 | $3.72 | (14.5%) |
| Cash flow from operations | $250.1 million | $213.7 million | 17.0% |
| Capital expenditures | $66.6 million | $62.8 million | 6.1% |
| Free cash flow | $183.5 million | $150.9 million | 21.6% |
License-based revenue increased 15.6% to $662.9 million, asset-based revenue increased 10.3% to $187.3 million, and transaction-based revenue increased 11.1% to $61.5 million. Organic revenue increased 7.6%, excluding acquisitions, divestitures, and foreign-currency effects.
Key product revenue included Morningstar Data of $162.9 million, Morningstar Direct of $124.4 million, Morningstar Investment Management of $106.0 million, Advisor Workstation of $87.3 million, Workplace Solutions of $73.5 million, PitchBook of $63.6 million, and Morningstar Credit Ratings of $31.4 million.
Operating expense increased 20.1% to $741.9 million. The increase reflected full-year PitchBook costs, higher compensation and bonuses, increased depreciation and amortization, professional fees, and continued investment in technology and product development. PitchBook generated $76.0 million of operating expense, including $10.6 million of intangible amortization and $7.9 million of performance-award vesting costs.
Fourth-quarter results
| Metric | Q4 2017 | Q4 2016 |
|---|---|---|
| Revenue | $243.1 million | $212.2 million |
| Operating income | $42.6 million | $49.9 million |
| Operating margin | Approximately 17.5% | Approximately 23.5% |
| Consolidated net income | $38.9 million | $70.3 million |
| Diluted EPS | $0.91 | $1.63 |
Q4 2016 included a $37.1 million non-cash holding gain related to the acquisition of the remaining PitchBook interest. Q4 2017 included a $10.6 million net tax benefit from U.S. tax reform, which partially offset the year-over-year decline in reported net income caused by the prior-year PitchBook gain and higher operating costs.
Liquidity, debt, and capital allocation
- Cash, cash equivalents, and investments totaled $353.3 million at year-end, including $308.2 million of cash and cash equivalents and $45.1 million of investments.
- Long-term debt was $180.0 million, down from $250.0 million, after $70.0 million of repayments. The company had $120.0 million of remaining borrowing availability under its $300.0 million revolving facility.
- The company complied with its maximum 3.00-to-1 leverage covenant and minimum 3.00-to-1 interest-coverage covenant.
- Approximately 69% of cash, cash equivalents, and investments was held outside the United States.
- Morningstar repurchased approximately 0.5 million shares for $41.9 million in 2017 and paid $39.3 million of dividends.
- A new $500.0 million share-repurchase authorization became effective January 1, 2018. Management expected regular quarterly dividends of $0.25 per share in 2018.
- Management stated that cash, investments, operating cash flow, and the credit facility should meet operating and cash needs for at least the next 12 months.
Material changes, outlook, and unusual items
- PitchBook: Full-year consolidation materially increased revenue and expenses. Excluding PitchBook, adjusted operating income was $182.2 million, compared with $184.1 million in 2016; adjusted operating margin was 21.5%, compared with 23.2%.
- HelloWallet divestiture: Sold in June 2017 for $23.7 million of proceeds and recognized a $16.7 million gain. The business contributed no comparable second-half revenue.
- Sustainalytics investment: Acquired a 40% minority interest in July 2017; the investment was recorded at $20.7 million at year-end.
- Technology investment: Capitalized software development costs increased to $46.3 million from $28.2 million. A $4.1 million impairment charge was recorded for software licenses as the company shifted toward cloud-based infrastructure.
- Tax reform: The company recorded a provisional $10.6 million net tax benefit related to the Tax Cuts and Jobs Act. The accounting remained incomplete and could change materially as analysis and guidance developed.
- Accounting outlook: ASC 606 revenue recognition was scheduled for adoption on January 1, 2018 using the modified retrospective method. Management expected no material change in revenue timing, but anticipated a $6 million to $7 million increase in reported revenue and cost of revenue from certain gross versus net presentations, plus a $25 million to $30 million increase in opening retained earnings from capitalizing qualifying sales commissions.
- Management guidance: Morningstar does not provide public financial forecasts or earnings guidance. The filing does not provide numerical 2018 revenue or earnings guidance.
Principal risks and contingencies
- Exposure to market declines and asset outflows because approximately 21% of 2017 revenue was asset-based.
- Industry movement toward passive investments, fee pressure, asset-manager consolidation, and regulatory changes including MiFID II, fiduciary standards, benchmark regulation, and GDPR.
- Fiduciary, investment-advisory, credit-rating, data-accuracy, privacy, cybersecurity, and intellectual-property liabilities.
- Operational concentration and business-continuity risks involving technology, cloud migration, and data and development centers in China, India, and Ukraine.
- An August 2017 putative class action alleged RICO violations related to steering retirement-plan participants toward high-cost investments. Morningstar filed a motion to dismiss; the outcome could not be predicted, and the filing did not quantify potential damages.
- Joe Mansueto owned approximately 57% of outstanding common stock, giving him substantial control over shareholder matters.
Investor verification checklist
- Reconcile reported revenue growth with the $57.5 million acquisition contribution from PitchBook and the 7.6% organic-growth figure.
- Assess whether PitchBook revenue growth and eventual profitability offset its significant operating costs, amortization, and performance-award expense.
- Monitor operating-margin recovery as cloud migration, product development, compensation, and sales investments continue.
- Verify the final accounting effects of ASC 606, including commission capitalization and gross-versus-net revenue presentation.
- Review the final tax accounting for the Tax Cuts and Jobs Act, including deemed repatriation, foreign withholding taxes, BEAT, and GILTI.
- Track debt repayment, covenant headroom, overseas cash balances, share repurchases, and dividend capacity.
- Follow developments in the retirement-plan litigation and evaluate potential fiduciary and regulatory exposure.
- Evaluate sensitivity to market levels, passive-investing trends, asset-based fee compression, foreign exchange, cybersecurity incidents, and service outages.