Morningstar, Inc. — Q1 2017 Form 10-Q Summary
Business context and reporting period
Morningstar provides data, research, software, investment management, workplace retirement, credit ratings, and related services to individual investors, advisors, asset managers, retirement providers, and institutional investors. Revenue is generated primarily from subscription and license agreements, asset-based fees, and transaction-based services. This unaudited quarterly report covers the three months ended March 31, 2017, compared with the same period in 2016.
Financial performance and liquidity
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Revenue | $209.5 million | $192.1 million | 9.1% |
| Operating income | $28.4 million | $42.3 million | (32.8%) |
| Operating margin | 13.6% | 22.0% | (8.4 percentage points) |
| Net income | $18.0 million | $28.7 million | (37.3%) |
| Diluted EPS | $0.42 | $0.67 | (37.3%) |
| Cash flow from operations | $46.5 million | $11.4 million | 307.9% |
| Capital expenditures | $14.3 million | $13.5 million | 5.9% |
| Free cash flow | $32.2 million | $(2.1) million | Not meaningful |
- Revenue growth included $13.1 million from PitchBook, acquired in December 2016, and was reduced by approximately $1.9 million by foreign-currency translation. Organic revenue increased 3.1%.
- License-based revenue increased 11.5% to $155.5 million; asset-based revenue increased 6.6% to $43.6 million; transaction-based revenue declined 11.7% to $10.4 million.
- Cash, cash equivalents, and investments totaled $317.5 million at March 31, 2017, compared with $304.0 million at December 31, 2016.
- Long-term debt was $235.0 million, down from $250.0 million at year-end. The company had $65.0 million of remaining borrowing availability under its $300.0 million revolving facility and complied with its covenants.
- The effective tax rate was 31.6%, compared with 33.7% in Q1 2016.
Material changes versus the prior comparable period
- PitchBook added revenue and operating costs, including $18.7 million of operating expense. Excluding PitchBook, adjusted operating income was $33.9 million, down 19.7%, and adjusted operating margin was 17.3%, down 4.7 percentage points.
- Total operating expense increased 20.9% to $181.1 million. Cost of revenue, sales and marketing, general and administrative expense, and depreciation and amortization all increased as percentages of revenue.
- Compensation expense increased $13.0 million, bonus expense increased $4.7 million, and sales commission expense increased $3.2 million. Worldwide headcount increased to approximately 4,590 from 4,000, including approximately 330 PitchBook employees.
- Workplace Solutions revenue increased 10.5%, Morningstar Direct revenue increased 7.4%, and Morningstar Data revenue increased 4.7%. Advisor Workstation revenue declined 3.9%.
- Internet advertising revenue declined $1.3 million because advertisers continued shifting toward programmatic platforms. Credit Ratings revenue was also pressured by weaker commercial mortgage-backed securities issuance.
- Operating cash flow improved primarily because of net working-capital movements, including a $22.1 million increase in deferred revenue, partially offset by bonus payments and other compensation-related cash uses.
Guidance, outlook, risks, contingencies, and unusual items
- The filing does not provide specific full-year revenue or earnings guidance. Management expects continued 2017 capital expenditures for computer hardware and software, internally developed software, and office improvements.
- Management believes cash, investments, operating cash generation, and available credit will be sufficient to meet operating and cash needs for at least the next 12 months.
- Management cited opportunities from increased demand for investor-focused advice and fiduciary solutions, but noted continued pressure from low interest rates, the shift toward passive investing, lower industry spending, and regulatory uncertainty.
- Key risks include market volatility affecting asset-based fees, technology or database outages, cybersecurity and personal-information liabilities, data accuracy or redistribution claims, regulatory and compliance changes, acquisition execution, foreign-currency exposure, and challenges in non-U.S. operations.
- The company had approximately $18.7 million of gross unrecognized tax benefits at March 31, 2017 and was subject to tax audits in U.S. and non-U.S. jurisdictions. The effect of current audits could not be estimated.
- Routine legal proceedings were not expected to have a material adverse effect. No goodwill impairment was recorded in Q1 2017 or Q1 2016.
- The company had not completed any acquisitions during Q1 2017, but the preliminary purchase-price allocation for the PitchBook acquisition remained subject to finalization for certain intangible assets, deferred taxes, deferred revenue, and tax items.
- The company adopted a quarterly dividend of $0.23 per share and retained approximately $326.8 million under its $1.0 billion share-repurchase authorization, which expires December 31, 2017.
- Approximately 71% of cash, cash equivalents, and investments was held outside the United States. The company does not currently hedge currency exposure. A 100-basis-point increase in LIBOR was estimated to increase annual interest expense by approximately $2.4 million.
Most important facts for investors to verify
- Whether PitchBook revenue growth and integration benefits offset its near-term operating-cost and margin dilution.
- Whether organic revenue growth can improve from 3.1% while advertising and credit-ratings markets remain pressured.
- The sustainability of the materially lower operating margin and the effect of continued hiring, bonuses, commissions, amortization, and software investment.
- Cash generation, debt repayment, remaining revolver availability, and compliance with the 3.00-to-1.00 leverage and minimum 3.00-to-1.00 interest-coverage covenants.
- Exposure to foreign exchange, asset-based fee volatility, passive-investing trends, regulatory changes, tax audits, and the concentration of development operations in China and India.
- The effect of planned adoption of the new revenue-recognition standard on or after January 1, 2018; the company had not yet finalized its adoption method or quantified the impact.