Morningstar, Inc. 2020 Q3 Form 10-Q Summary
Business context and reporting period
Morningstar, Inc. filed an unaudited Form 10-Q for the three and nine months ended September 30, 2020. The company provides investment data, research, analytics, software, investment management, workplace solutions, and credit ratings. It reports as one operating segment and generates revenue from license-based, asset-based, and transaction-based products.
The results include the July 2, 2020 acquisition and consolidation of the remaining 60% interest in Sustainalytics, an ESG ratings and research business. COVID-19 continued to affect operating conditions, although management reported minimal interruption to customer service and relatively little productivity disruption from remote work.
Key financial metrics
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Revenue | $357.2 million | $313.8 million | $1,009.1 million | $846.6 million |
| Revenue growth | 13.8% | — | 19.2% | — |
| Operating income | $44.3 million | $49.6 million | $150.1 million | $149.9 million |
| Operating margin | 12.4% | 15.8% | 14.9% | 17.7% |
| Net income | $76.2 million | $49.1 million | $148.3 million | $124.4 million |
| Diluted EPS | $1.76 | $1.14 | $3.43 | $2.89 |
| Cash from operations | $93.4 million | $105.7 million | $269.7 million | $251.9 million |
| Free cash flow | $70.8 million | $85.6 million | $215.0 million | $194.8 million |
License-based revenue increased 18.7% in Q3 and 13.1% for the first nine months, supported by PitchBook, Sustainalytics, Morningstar Data, and Morningstar Direct. Asset-based revenue increased 1.7% in Q3 and 5.5% year to date. Transaction-based revenue increased 7.7% in Q3 and 83.6% year to date, primarily because of DBRS Morningstar. Organic revenue growth was 8.0% in Q3 and 8.4% for the first nine months.
Adjusted operating income, excluding intangible amortization and merger-and-acquisition-related expenses including acquisition earn-outs, was $91.2 million in Q3 and $232.1 million for the first nine months. Adjusted operating margin was 25.6% and 23.1%, respectively, compared with 20.4% and 20.8% in the prior-year periods.
Cash and cash equivalents were $351.1 million at September 30, 2020, and total cash, cash equivalents, and investments were $377.8 million. Total debt was $484.9 million, including $473.9 million of long-term debt. The company had $250.0 million of availability under its principal revolving facility and was in compliance with its leverage and interest-coverage covenants. Approximately 66% of cash, cash equivalents, and investments was held outside the United States.
Material changes versus the prior comparable period
- Revenue growth was partly acquisition-driven, particularly from DBRS Morningstar and Sustainalytics, while organic growth remained positive.
- Operating income was down 10.7% in Q3 and essentially flat for the first nine months despite higher revenue. Total operating expense increased 18.4% in Q3 and 23.3% year to date.
- General and administrative expense increased 50.0% in Q3, primarily due to acquisition-related earn-outs, compensation, rent, and professional fees. The $27.8 million Sustainalytics acquisition earn-out was recorded as compensation expense.
- Intangible amortization increased to $15.6 million in Q3 and $43.3 million year to date, mainly due to DBRS and Sustainalytics acquisitions.
- Net income benefited from a $50.9 million non-cash holding gain on the previously held Sustainalytics interest. The prior-year comparison included a $19.5 million gain on the sale of an equity-method investment.
- Operating cash flow increased 7.1% year to date, but declined 11.6% in Q3 due primarily to working-capital timing. Year-to-date free cash flow increased 10.4%.
- Goodwill increased from $1,039.1 million at year-end 2019 to $1,178.1 million at September 30, 2020, including $135.1 million from Sustainalytics.
- The company repurchased 122,020 shares for $19.3 million in Q3. Approximately $435.1 million remained available under the repurchase authorization, which expires December 31, 2020.
Guidance, outlook, commentary, risks, and unusual items
The filing does not provide formal quantitative revenue or earnings guidance. Management expects cash balances, operating cash flow, and available credit to be sufficient for operating and cash needs for at least the next 12 months. The company expects continued capital spending on hardware, software, internally developed software, leasehold improvements, and migration of portions of its infrastructure to public cloud providers.
On October 26, 2020, after quarter-end, Morningstar issued $350.0 million of 2.32% senior notes due October 26, 2030. Proceeds were expected to reduce outstanding Credit Agreement borrowings and support other corporate purposes. The company also sold 3.85 million shares of Morningstar Japan K.K. for $16.0 million of net proceeds and recognized a $12.2 million pretax gain, and sold an approximately 19% interest in another unconsolidated entity for $14.3 million, recognizing a $12.6 million pretax gain.
COVID-19 remains the principal near-term uncertainty. A prolonged downturn could reduce subscription demand, delay implementations, increase cancellations or pricing pressure, lower assets under management and related fees, and reduce credit issuance and ratings activity. Other identified risks include cybersecurity and data protection, regulatory action involving investment advisory and credit ratings operations, technology outages, data-license audits, acquisition integration, foreign-currency exposure, and employee retention.
Morningstar Credit Ratings, LLC received an SEC Wells Notice concerning its former commercial mortgage-backed securities ratings methodology. Management stated that it did not believe the matter would have a material adverse effect, but the outcome remains uncertain. The company also disclosed that data-license audits and reviews could result in payments for prior data usage, although potential losses generally could not be reasonably estimated.
Important facts for investors to verify
- Assess the sustainability of organic growth excluding DBRS Morningstar and Sustainalytics, and distinguish recurring license and surveillance revenue from transaction-based revenue.
- Monitor operating-margin pressure from acquisition earn-outs, higher compensation, professional fees, and ongoing intangible amortization.
- Review the final purchase-price allocation and contingent consideration for Sustainalytics, including payments tied to 2020 and 2021 revenue metrics.
- Confirm the use of proceeds from the post-quarter-end $350.0 million senior-notes issuance and the resulting debt, interest expense, and covenant profile.
- Evaluate COVID-19 effects on asset-based fees, credit issuance, customer renewals, implementation timing, and employee productivity.
- Track the SEC Wells Notice involving Morningstar Credit Ratings, data-license audits, and other regulatory or litigation contingencies.
- Consider foreign-exchange risk, including the company’s estimate that a 100-basis-point LIBOR change would affect annual interest expense by approximately $4.9 million.
- Verify the impact of the October 2020 asset sales and gains, which were subsequent events and were not reflected in the September 30, 2020 balance sheet.