Morningstar, Inc. — Q3 2019 Form 10-Q Summary
Business context and reporting period
Morningstar provides investment data, research, analytics, software, investment management, workplace solutions, and credit-rating services. This unaudited Form 10-Q covers the three and nine months ended September 30, 2019, compared with the corresponding 2018 periods.
Morningstar completed the $682.1 million cash acquisition of DBRS on July 2, 2019. DBRS was consolidated beginning on that date and combined with Morningstar’s existing credit-ratings operations as DBRS Morningstar.
Financial performance and liquidity
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Revenue | $313.8 million | $261.3 million | $846.6 million | $757.2 million |
| Operating income | $49.6 million | $65.4 million | $149.9 million | $166.5 million |
| Operating margin | 15.8% | 25.0% | 17.7% | 22.0% |
| Net income | $49.1 million | $56.9 million | $124.4 million | $140.6 million |
| Diluted EPS | $1.14 | $1.32 | $2.89 | $3.27 |
| Cash flow from operations | $105.7 million | $79.8 million | $251.9 million | $209.5 million |
| Free cash flow | $85.6 million | $60.2 million | $194.8 million | $154.3 million |
- Revenue increased 20.1% in Q3 and 11.8% for the first nine months. Organic revenue, excluding acquisitions and foreign-currency effects, increased 5.6% and 7.9%, respectively.
- License-based revenue rose 4.0% in Q3 and 7.4% year to date; asset-based revenue rose 7.9% and 4.0%. Transaction-based revenue rose 287.9% in Q3 and 87.7% year to date, primarily because of DBRS Morningstar.
- Adjusted operating income, excluding acquisition-related amortization and integration expenses, was $64.1 million in Q3 and $175.9 million for the first nine months. Adjusted operating margins were 20.4% and 20.8%, respectively.
- Cash and investments totaled $352.8 million at September 30, 2019, down from $395.9 million at December 31, 2018. Cash and cash equivalents were $321.8 million.
- Total debt was $545.8 million, including $445.8 million under the term facility and $100.0 million drawn on the revolving facility. Revolving borrowing availability was $200.0 million.
- The company was in compliance with its maximum leverage and minimum interest-coverage covenants at September 30, 2019. Management stated that available cash, operating cash flow, and borrowing capacity should meet operating and cash needs for at least the next 12 months.
Material changes versus the prior comparable period
- DBRS Morningstar contributed $49.6 million of Q3 revenue and $51.6 million of operating expense. The acquisition added $468.3 million of goodwill and $288.2 million of identifiable intangible assets.
- Operating expenses increased 34.9% in Q3 and 17.9% year to date, outpacing revenue growth. Increases reflected DBRS-related costs, higher headcount, software and product investment, rent, stock-based compensation, and amortization.
- Operating margin declined 9.2 percentage points in Q3 and 4.3 percentage points year to date. Intangible amortization increased to $13.3 million in Q3 from $5.2 million.
- Q3 net income included a $19.5 million gain on the sale of an equity investment. The prior-year periods included a $10.5 million gain on the sale of a product line and a $5.6 million equity-investment gain.
- Interest expense increased as a result of the new debt used to finance DBRS. A 100-basis-point increase in LIBOR was estimated to increase annualized interest expense by approximately $5.5 million.
- Operating lease assets of $138.2 million and lease liabilities of $165.6 million were recognized following adoption of the new lease accounting standard on January 1, 2019.
- Employees increased to 6,557 from 5,230 at September 30, 2018, including approximately 502 employees from DBRS.
Guidance, outlook, risks, and unusual items
The filing does not provide formal quantitative revenue or earnings guidance. Management expects continued capital expenditures for hardware, software, internally developed technology, and office expansion, and expects to migrate relevant data-center infrastructure to the public cloud over several years. The company expects approximately $10.4 million of intangible-amortization expense during the remainder of 2019.
- Management identified integration and execution risks related to DBRS, including the possibility that anticipated synergies and results are not achieved.
- Other principal risks include financial-market and asset-level volatility, pressure from lower-fee passive investment products, credit-rating regulation, data licensing and accuracy, cybersecurity and privacy, technology outages, foreign-currency exposure, employee retention, and intellectual-property claims.
- Approximately 72% of cash, cash equivalents, and investments were held outside the United States at September 30, 2019. The company generally considers certain foreign earnings permanently reinvested.
- The company was undergoing third-party data-license audits and internal reviews. Potential losses could not be reasonably estimated for some matters, although management did not believe the audits would have a material adverse effect.
- Foreign-currency movements reduced revenue by approximately $2.6 million in Q3 and $11.1 million year to date. The company does not currently hedge currency risk.
- Unrecognized tax benefits totaled $12.6 million, and related liabilities totaled $13.7 million at September 30, 2019.
Important facts for investors to verify
- Progress integrating DBRS Morningstar, including revenue growth, cost synergies, credit-rating volumes, and leverage reduction.
- Whether organic growth in PitchBook, Morningstar Data, and Morningstar Direct offsets weaker advertising and fee-compression trends.
- The sustainability of operating margins after acquisition-related amortization, integration costs, and continued investment spending.
- Debt balances, interest-rate exposure, covenant compliance, and available revolving-credit capacity.
- Cash generation after acquisitions, capital expenditures, dividends, share repurchases, and foreign-cash restrictions.
- Potential outcomes of data-license audits, tax examinations, regulatory matters, and other contingencies.
- The filing’s non-GAAP adjusted operating income, adjusted margin, organic revenue, and free-cash-flow measures should be reconciled to GAAP results and compared with later filings.