Morningstar, Inc. 2019 Form 10-K Summary
Business context and reporting period
Morningstar is a global provider of investment data, research, ratings, software, indexes, and investment-management services for individual investors, advisors, asset managers, retirement-plan providers, and private-market investors. The filing covers the fiscal year ended December 31, 2019. The requested “2019 Q4” period corresponds to the fourth quarter within this annual filing; quarterly data are unaudited.
Morningstar completed the $669.0 million acquisition of DBRS on July 2, 2019 and combined it with Morningstar Credit Ratings under the DBRS Morningstar brand. The company also acquired AdviserLogic and Cuffelinks, now FirstLinks, in the fourth quarter.
Financial performance and key metrics
| Metric | 2019 | 2018 | Change |
|---|---|---|---|
| Revenue | $1,179.0 million | $1,019.9 million | 15.6% |
| Operating income | $189.6 million | $215.8 million | (12.1%) |
| Operating margin | 16.1% | 21.2% | (5.1 percentage points) |
| Net income attributable to Morningstar | $152.0 million | $183.0 million | (16.9%) |
| Diluted EPS | $3.52 | $4.25 | (17.2%) |
| Cash flow from operations | $334.4 million | $314.8 million | 6.2% |
| Capital expenditures | $80.0 million | $76.1 million | 5.1% |
| Free cash flow | $254.4 million | $238.7 million | 6.6% |
Revenue mix was $812.7 million license-based, $211.6 million asset-based, and $154.7 million transaction-based. These represented approximately 68.9%, 18.0%, and 13.1% of consolidated revenue, respectively.
Key product revenue included Morningstar Data of $196.8 million, Morningstar Direct of $148.6 million, PitchBook of $148.4 million, DBRS Morningstar of $127.6 million, and Morningstar Investment Management of $115.9 million. PitchBook Platform licenses increased to 36,695 from 22,979, while Morningstar Direct licenses increased to 15,903 from 15,033.
Fourth-quarter 2019 revenue was $332.4 million, operating income was $39.7 million, and net income was $27.6 million, compared with fourth-quarter 2018 revenue of $262.7 million, operating income of $49.3 million, and net income of $42.4 million. Fourth-quarter diluted EPS was $0.64 versus $0.99 in the prior-year quarter.
International revenue was $312.6 million, or approximately 27% of consolidated revenue, compared with 25% in 2018. Weighted average annual renewal rates for contract-based products were approximately 102%, compared with 100% in 2018.
Material changes versus the prior comparable period
- Revenue growth was materially affected by the DBRS acquisition, which contributed $127.6 million of 2019 revenue and $123.5 million of operating expense. Organic revenue growth was 8.4%, or 9.5% excluding the nonrecurring $10.5 million 2018 license-amendment benefit.
- Transaction-based revenue increased 127.8%, primarily because of DBRS. Excluding DBRS, transaction-based revenue declined 14.2%, mainly due to lower Morningstar.com advertising revenue.
- Operating expenses increased 23.0%, exceeding revenue growth. Increases reflected DBRS integration and amortization, higher headcount, technology and cloud costs, rent, stock-based compensation, and investment in product development and sales.
- Adjusted operating income, excluding M&A-related expenses and intangible amortization, was $233.3 million, down 1.4% from $236.5 million. Adjusted operating margin declined to 19.8% from 23.2%.
- Interest expense increased following the DBRS financing. Non-operating income included a $19.5 million gain from selling an equity-method investment, while 2018 included a $10.5 million gain from selling a product line.
- Cash used in investing activities increased to $746.3 million, primarily because of $681.9 million spent on acquisitions, net of cash acquired.
- Cash, cash equivalents, and investments declined to $367.5 million from $395.9 million. Total debt increased to $513.1 million from $70.0 million, and long-term liabilities increased to $791.5 million from $156.3 million.
Liquidity, debt, outlook, and risks
At December 31, 2019, Morningstar had $334.1 million of cash and cash equivalents, $33.4 million of investments, and $230.0 million of available borrowing capacity under its revolving credit facility. The five-year credit agreement expires July 2, 2024 and includes a $450.0 million term facility and a $300.0 million revolving facility. The company was in compliance with its maximum leverage ratio of 3.50-to-1.00, or 3.75-to-1.00 following a material acquisition, and minimum interest coverage ratio of 3.00-to-1.00.
Management stated that cash balances, operating cash flow, and available borrowing capacity should be sufficient for operating and cash needs for at least the next 12 months. The company does not provide public financial forecasts or earnings guidance. It expected regular quarterly dividends of $0.30 per share in 2020, subject to board approval.
Management expects continued investment in software, technology, cloud migration, product development, and international operations. The company identified Regulation Best Interest, the SECURE Act, ESG-related regulation, data privacy requirements, and demand for retirement and compliance solutions as potential opportunities.
- DBRS Morningstar integration, acquisition execution, goodwill and intangible-asset valuation, and increased leverage.
- Variable-rate debt exposure: a 100-basis-point LIBOR increase was estimated to affect annualized interest expense by approximately $5.1 million.
- Market downturns could reduce asset-based fees, investment-management assets, credit-rating issuance volumes, and PitchBook activity.
- Fiduciary, regulatory, litigation, and reputational exposure related to investment advice, retirement accounts, credit ratings, data, and research.
- Cybersecurity, privacy, cloud-provider, data-center, and business-continuity risks, including concentration of operations in China and India.
- Brexit-related restructuring and potential loss of U.K. passporting rights for European investment-management activities.
- A proposed SEC settlement relating to Morningstar Credit Ratings sales and marketing practices included a $3.5 million accrued civil penalty and remained subject to SEC approval.
- Third-party data audits and licensing reviews were ongoing; the filing states that potential losses could not be reasonably estimated for some matters.
Important facts for investors to verify
- Verify the sustainability of organic growth after excluding DBRS, foreign exchange effects, and the 2018 nonrecurring license benefit.
- Assess whether DBRS integration can improve operating leverage while reducing acquisition-related amortization and expenses.
- Monitor debt repayment, leverage and interest coverage compliance, LIBOR or successor-rate exposure, and the July 2024 credit-facility maturity.
- Evaluate the effect of market conditions on assets under management and advisement, credit-rating issuance volumes, and PitchBook demand.
- Review goodwill of $1.039 billion and intangible assets of $333.4 million for impairment and valuation sensitivity.
- Follow the proposed credit-ratings settlement, data-license audits, fiduciary litigation exposure, and evolving privacy and cybersecurity requirements.
- Note that management’s internal-control assessment and the auditor’s opinion excluded DBRS internal controls as of December 31, 2019 while integration was ongoing.
- Confirm quarterly trends separately from annual results because fourth-quarter operating margin and diluted EPS were materially below the prior-year quarter.