Morningstar, Inc. 2018 First-Quarter Form 10-Q Summary
Business Context and Reporting Period
Morningstar, Inc. filed an unaudited Form 10-Q for the three months ended March 31, 2018. The company provides investment research, data, software, investment management, workplace solutions, credit ratings, advertising, and related services. Revenue is generated primarily from license-based subscriptions, asset-based fees, and transaction-based services.
Financial Performance and Position
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Revenue | $243.5 million | $209.5 million | 16.2% |
| Operating income | $47.5 million | $28.4 million | 67.2% |
| Operating margin | 19.5% | 13.6% | Up 5.9 percentage points |
| Net income | $41.9 million | $18.0 million | Increase of $23.9 million |
| Diluted EPS | $0.98 | $0.42 | Increase of $0.56 |
| Cash provided by operating activities | $59.9 million | $46.5 million | 28.8% |
| Free cash flow | $42.3 million | $32.2 million | 31.4% |
- Revenue by type was $178.6 million license-based, $50.7 million asset-based, and $14.2 million transaction-based. Each category increased year over year.
- Estimated net income margin was approximately 17.2%, compared with approximately 8.6% in Q1 2017.
- Cash, cash equivalents, and investments totaled $355.4 million at March 31, 2018, including $311.0 million of cash and cash equivalents.
- Long-term debt was $150.0 million, down from $180.0 million at December 31, 2017. The company had $150.0 million of remaining borrowing availability under its $300.0 million facility, which expires in November 2019.
- The company was in compliance with its maximum leverage and minimum interest coverage covenants.
- Total assets were $1.44 billion and shareholders’ equity was $858.3 million at March 31, 2018.
- Capital expenditures were $17.6 million, compared with $14.3 million in the prior-year quarter.
- The quarterly dividend was increased to $0.25 per share from $0.23 per share in Q1 2017. The company repurchased 92,529 shares for $8.9 million and had approximately $491.1 million remaining under its $500 million authorization.
Material Changes Versus the Prior Comparable Period
- Revenue growth was driven by PitchBook Data, Morningstar Data, Morningstar Direct, Morningstar Managed Portfolios, Workplace Solutions, Morningstar Credit Ratings, and advertising.
- Organic revenue increased 13.7%, excluding acquisitions, divestitures, the effect of accounting changes, and foreign currency translation. Foreign currency translation increased reported revenue by approximately $5.6 million.
- Operating expenses increased 8.2%, slower than revenue growth. Cost of revenue declined as a percentage of revenue to 42.1% from 46.3%, supporting margin expansion.
- Net income benefited from a $10.5 million gain on the sale of the 15(c) board consulting services product line. This gain did not recur in the prior-year period.
- The effective tax rate declined to 24.2% from 31.6%, primarily because of the reduction in the U.S. federal corporate tax rate from 35% to 21% and tax benefits associated with the Foreign-Derived Intangible Income deduction.
- Average assets under management and advisement declined to $198.2 billion from $202.4 billion, reflecting a strategic shift away from customized investment management toward Managed Portfolios.
- PitchBook Platform licenses increased 51.4% to 15,488, while Morningstar Direct licenses increased 9.2% to 14,111.
- Morningstar adopted ASC Topic 606 on January 1, 2018 using the modified retrospective method. The adoption increased opening retained earnings by $17.0 million and created $26.1 million of deferred commission assets at March 31, 2018. Reported Q1 revenue and cost of revenue each increased by $1.7 million without affecting operating income.
Guidance, Outlook, Commentary, Risks, and Unusual Items
- Management stated that cash, investments, operating cash flow, and available credit are expected to be sufficient for operating and cash needs for at least the next 12 months.
- Management expects continued 2018 capital expenditures for hardware, software, internally developed software, and office improvements. The company has begun migrating infrastructure to the cloud, which may temporarily affect capital expenditures and operating expenses and may require redundant infrastructure during the transition.
- Management expects approximately $15.5 million of intangible amortization expense for the remainder of 2018, subject to acquisitions, divestitures, useful-life changes, and foreign currency movements.
- Approximately 74% of cash, cash equivalents, and investments were held outside the United States, creating foreign cash concentration and repatriation considerations.
- Key risks include market volatility affecting asset-based fees, industry movement toward passive investing, technology and cybersecurity disruptions, data and intellectual-property liability, regulatory or compliance changes, fiduciary-duty claims, acquisition and investment performance, employee retention, foreign operations, and currency fluctuations.
- The company estimated that a 100-basis-point increase in LIBOR would increase annual interest expense by approximately $1.5 million. The company does not hedge its foreign currency exposure.
- Morningstar Investment Management LLC is defending an amended putative class action alleging violations of RICO related to investment fees. The company cannot predict the outcome, but does not believe other ordinary-course proceedings will materially affect its business or financial position.
- Tax accounting for the Tax Reform Act remained subject to ongoing analysis, including the company’s GILTI accounting policy election and possible changes to provisional tax amounts.
Important Facts for Investors to Verify
- Whether revenue growth and margin expansion persist after excluding the $10.5 million product-line sale gain, foreign currency benefit, and ASC 606 presentation effects.
- The sustainability of growth in PitchBook, Morningstar Data, Morningstar Direct, Managed Portfolios, and Workplace Solutions.
- The effect of the shift away from customized investment management on asset levels, revenue mix, and margins.
- Progress and costs associated with the cloud infrastructure migration and elevated software development investment.
- Future cash deployment among debt repayment, dividends, share repurchases, capital expenditures, and potential acquisitions.
- Potential changes from the unresolved GILTI tax analysis, foreign tax positions, and ongoing tax audits.
- The status and potential exposure of the amended RICO litigation and other regulatory or legal matters.