Morningstar, Inc. 2020 Q2 Form 10-Q Summary
Business Context and Reporting Period
Morningstar, Inc. provides investment research, data, analytics, software, investment management, workplace solutions, and credit ratings services. The filing covers the three and six months ended June 30, 2020. Financial statements are unaudited and prepared under U.S. GAAP.
The business reports one operating segment and generates revenue from license-based subscriptions, asset-based fees, and transaction-based services. Results include the combined DBRS Morningstar credit ratings operation following the July 2019 DBRS acquisition.
Key Financial Metrics
| Metric | Q2 2020 | Q2 2019 | Six Months 2020 | Six Months 2019 |
|---|---|---|---|---|
| Revenue | $327.9 million | $273.9 million | $651.9 million | $532.8 million |
| Operating income | $61.3 million | $50.8 million | $105.8 million | $100.3 million |
| Operating margin | 18.7% | 18.5% | 16.2% | 18.8% |
| Net income | $48.2 million | $42.1 million | $72.1 million | $75.3 million |
| Diluted EPS | $1.12 | $0.98 | $1.67 | $1.75 |
| Cash from operations | $127.6 million | $87.2 million | $176.3 million | $146.2 million |
| Free cash flow | $110.6 million | $68.9 million | $144.2 million | $109.2 million |
Q2 revenue increased 19.7%, operating income increased 20.7%, and net income increased 14.5%. Six-month revenue increased 22.4%, while operating income increased 5.5% and net income declined 4.3%. Adjusted operating income, excluding intangible amortization and M&A-related expenses, was $79.5 million in Q2 and $140.9 million for the six months; adjusted operating margin was 24.3% and 21.5%, respectively.
Q2 revenue consisted of $221.1 million of license-based revenue, $51.8 million of asset-based revenue, and $55.0 million of transaction-based revenue. Organic revenue growth was 5.8% in Q2 and 8.6% for the six months.
Liquidity, Debt, and Capital Allocation
- Cash, cash equivalents, and investments totaled $383.2 million at June 30, 2020, compared with $367.5 million at December 31, 2019.
- Total debt was $487.7 million, including $437.7 million under the term facility and $50.0 million under the revolving credit facility. Borrowing availability under the principal revolving facility was $250.0 million.
- A new undrawn $50.0 million 364-day revolving credit facility was entered into on June 30, 2020, bringing total revolving availability to approximately $300.0 million.
- The Company was in compliance with its maximum leverage ratio of 3.50 to 1.00 and minimum interest coverage ratio of 3.00 to 1.00.
- Six-month investing cash uses included $32.1 million of capital expenditures, $15.5 million for acquisitions, and $6.5 million for equity- and cost-method investments.
- The Company paid $25.7 million of dividends and repurchased $20.0 million of common stock during the first six months. Approximately $454.4 million remained available under the repurchase authorization, which expires December 31, 2020.
- The quarterly dividend was increased to $0.30 per share, payable July 31, 2020.
Material Changes Versus the Prior Comparable Period
- DBRS Morningstar contributed $39.1 million of Q2 revenue growth and $76.3 million of six-month revenue growth. It also materially increased operating expenses, compensation, amortization, professional fees, and integration costs.
- License-based revenue increased 10.1% in Q2 and 10.3% for the six months, led by PitchBook, Morningstar Data, and Morningstar Direct. PitchBook licenses increased 53.2% year over year to 45,039.
- Asset-based revenue declined 1.5% in Q2 but increased 7.4% for the six months. Average assets under management and advisement were $191.7 billion in Q2, down from $213.1 billion.
- Transaction-based revenue increased 169.6% in Q2 and 203.2% for the six months, principally because of DBRS Morningstar. Excluding the combined credit ratings operation, transaction-based revenue declined because of lower issuance activity, delayed conferences, and lower advertising revenue.
- Q2 operating margin improved slightly, but six-month operating margin declined 2.6 percentage points because of acquisition-related amortization and expenses.
- The effective tax rate increased to 24.0% in Q2 from 21.7% and to 24.7% for the six months from 23.6%, primarily because of minimum taxes and nondeductible expenses.
- Intangible amortization increased to $13.7 million in Q2 and $27.7 million for the six months, compared with $4.9 million and $9.8 million, respectively, in the prior-year periods.
Guidance, Outlook, Risks, and Unusual Items
The filing does not provide formal quantitative full-year revenue or earnings guidance. Management stated that it was implementing cost-control measures, prioritizing liquidity, and expected available cash, operating cash flow, and credit facilities to meet operating needs for at least the next 12 months.
COVID-19 had limited impact on recurring license-based revenue during Q2, but management identified material uncertainty. A prolonged downturn could reduce customer spending, delay implementations, increase cancellations, reduce asset-based fees, lower credit issuance volumes, and further affect conferences and advertising. Remote work and vendor operating arrangements could also create productivity, cybersecurity, technology, and business-continuity risks.
On July 2, 2020, after the reporting date, Morningstar completed its acquisition of the remaining approximately 60% of Sustainalytics. Consideration included EUR 54.5 million in cash at closing and additional contingent cash payments in 2021 and 2022 based on Sustainalytics revenue multiples.
Other notable matters include a preliminary SEC staff recommendation concerning a potential enforcement action related to a former Morningstar Credit Ratings methodology and a separate $3.5 million SEC settlement recorded as accrued at December 31, 2019. The Company did not expect these matters to have a material adverse effect. Third-party data-license audits and other legal or regulatory matters could result in payments, but the potential loss was not reasonably estimable.
Interest-rate exposure is material: a 100-basis-point change in LIBOR was estimated to affect annual interest expense by approximately $4.9 million. Approximately 70% of cash, cash equivalents, and investments were held outside the United States, and the Company had no currency hedges.
Important Facts for Investors to Verify
- Whether COVID-19-related weakness in credit issuance, asset values, conferences, advertising, and customer spending persists or intensifies.
- The sustainability of organic license-based growth, particularly PitchBook, Morningstar Data, and Morningstar Direct.
- The contribution, recurring revenue mix, integration costs, and regulatory exposure of DBRS Morningstar.
- Debt repayment capacity, covenant compliance, variable-rate interest exposure, and the use of the additional $50.0 million revolving facility.
- The financial impact, contingent consideration, and integration results of the Sustainalytics acquisition.
- The effect of elevated amortization, acquisition-related expenses, foreign exchange movements, and potential goodwill or intangible-asset impairment.
- Future share repurchases and dividend payments, particularly as the repurchase authorization expires at year-end 2020.
- Potential liabilities from SEC matters, tax audits, data-license audits, cybersecurity events, and other regulatory or legal proceedings.