Morningstar, Inc. 10-Q Summary
Reporting period: Three and six months ended June 30, 2021, compared with the same periods in 2020. The financial statements are unaudited and prepared under U.S. GAAP.
Business Context and Reporting Period
Morningstar provides investment data, research, analytics, software, investment management, workplace solutions, indexes, and credit ratings. Revenue is generated from license-based, asset-based, and transaction-based products. The company reports one operating segment.
Results include the ongoing integration of Sustainalytics, acquired in July 2020, and continued monitoring of COVID-19 effects. Management reported minimal disruption to product delivery and customer support, while noting continued uncertainty from new variants, market conditions, and customer purchasing decisions.
Financial Performance and Liquidity
| Metric | Q2 2021 | Q2 2020 | Six months 2021 | Six months 2020 |
|---|---|---|---|---|
| Revenue | $415.4 million | $327.9 million | $808.2 million | $651.9 million |
| Revenue growth | 26.7% | — | 24.0% | — |
| Operating income | $47.2 million | $61.3 million | $114.4 million | $105.8 million |
| Operating margin | 11.4% | 18.7% | 14.2% | 16.2% |
| Net income | $32.9 million | $48.2 million | $87.8 million | $72.1 million |
| Diluted EPS | $0.76 | $1.12 | $2.03 | $1.67 |
| Cash flow from operations | $127.2 million | $127.6 million | $191.4 million | $176.3 million |
| Free cash flow | $108.5 million | $110.6 million | $150.0 million | $144.2 million |
Q2 net margin was approximately 7.9%, compared with approximately 14.7% in the prior-year quarter. Six-month net margin was approximately 10.9%, compared with approximately 11.1% in the prior-year period.
- License-based revenue increased 25.4% in Q2 and 24.3% year to date; organic growth was 13.3% and 12.7%, respectively, excluding acquisitions and foreign currency effects.
- Asset-based revenue increased 25.1% in Q2 and 15.8% year to date, supported by Workplace Solutions, Investment Management, and Morningstar Indexes.
- Transaction-based revenue increased 33.5% in Q2 and 31.1% year to date, primarily because of stronger DBRS Morningstar activity and advertising revenue.
- Reported organic revenue growth was 16.7% in Q2 and 14.9% for the first six months. Foreign currency translation increased reported revenue by $13.6 million and $21.9 million, respectively.
- Adjusted operating income, excluding intangible amortization and M&A-related expenses, was $96.4 million in Q2 and $188.7 million year to date. Adjusted operating margin was 23.2% and 23.4%, respectively.
At June 30, 2021, cash, cash equivalents, and investments totaled $449.0 million. Cash and cash equivalents were $387.6 million, compared with $422.5 million at December 31, 2020. Approximately 64% of cash, cash equivalents, and investments was held outside the United States.
Long-term debt was $374.3 million, consisting primarily of $348.3 million of 2.32% senior notes due 2030 and $26.0 million outstanding under the term facility. The company had full availability under its $300.0 million revolving credit facility and was in compliance with debt covenants.
Material Changes Versus the Prior Comparable Period
- Revenue growth was strong, but Q2 operating income declined 23.0% because operating expenses rose 38.1%, outpacing revenue growth.
- The primary unusual expense was a $26.6 million increase in the estimated Sustainalytics acquisition earn-out, included in compensation expense. M&A-related earn-outs totaled $30.1 million in Q2 and $35.8 million year to date.
- Operating expenses also increased from higher compensation, sales commissions, advertising, software licenses, travel and conference activity, and Sustainalytics-related costs. The company had 8,777 employees at June 30, 2021, compared with 6,914 a year earlier.
- Capital expenditures increased to $41.4 million year to date from $32.1 million. Capitalized software development was $38.3 million, compared with $28.3 million in the prior-year period.
- Cash flow from operations increased 8.6% year to date, while free cash flow increased 4.0%. Excluding M&A-related earn-out payments, management stated that operating cash flow and free cash flow would have increased 18.0% and 15.5%, respectively.
- The company repaid $75.0 million of term debt and paid $34.4 million of acquisition-related earn-outs during the first six months. It made no repurchases under its $400.0 million share repurchase authorization.
- The effective tax rate increased to 29.7% in Q2 from 24.0%, primarily because the increased Sustainalytics earn-out estimate was not tax deductible. The six-month rate was 24.2%, compared with 24.7%.
Guidance, Outlook, Commentary, Risks, and Unusual Items
The filing does not provide a clear formal revenue, earnings, or margin outlook. Management stated that available liquidity, operating cash flow, and the revolving facility should be sufficient to meet operating and cash needs for at least the next 12 months.
- Management expects approximately $30.4 million of intangible amortization expense during the remainder of 2021, subject to acquisitions, divestitures, useful-life changes, impairment, and foreign currency movements.
- Management expects continued capital investment in hardware, third-party and internally developed software, leasehold improvements, and migration of portions of its data centers to public cloud infrastructure.
- Asset-based revenue remains sensitive to market levels and may reflect market movements with a one-quarter lag. Transaction-based revenue remains dependent on credit-market conditions and debt issuance.
- Key risks include COVID-19 and macroeconomic volatility, financial-market downturns, cybersecurity and data protection, regulatory action involving credit ratings and ESG products, acquisition integration, technology and operational failures, employee retention, foreign currency exposure, and indebtedness.
- Morningstar Credit Ratings, LLC is defending an SEC civil action concerning former commercial mortgage-backed securities ratings practices. The company recorded an immaterial accrual and does not expect a material adverse effect.
- DBRS reached an agreement in principle with SEC staff after the quarter-end regarding an investigation into ratings on five CLO combination notes. Subject to SEC approval, the proposed settlement includes a $1.0 million civil penalty, censure, a cease-and-desist order, and other undertakings.
- The company is subject to third-party data-license audits and reviews. The filing states that potential losses generally cannot be reasonably estimated, although management does not expect a material adverse effect.
Important Facts for Investors to Verify
- Whether strong reported revenue growth continues after separating Sustainalytics contributions and favorable foreign currency effects from organic growth.
- Progress in converting revenue growth into operating-margin improvement, particularly after the Sustainalytics earn-out and integration costs normalize.
- The final Sustainalytics earn-out payment due in 2022 and the assumptions supporting the $18.2 million contingent consideration liability at June 30, 2021.
- DBRS and Morningstar Credit Ratings regulatory matters, including the proposed $1.0 million DBRS settlement and any changes in accrued liabilities.
- Market levels, asset flows, credit issuance, and the timing lag affecting asset-based and transaction-based revenue.
- Cash deployment priorities, including debt repayment, dividends, the unused $400.0 million share repurchase authorization, capital expenditures, and cloud migration costs.
- Integration of Sustainalytics into Morningstar’s internal control framework; management expects to include it in the annual internal-control assessment for 2021.