Morningstar, Inc. — Q1 2019 Form 10-Q Summary
Business context and reporting period
Morningstar provides investment data, research, analytics, software, investment-management, workplace, index, and credit-rating services to institutions, advisors, and individuals. This unaudited Form 10-Q covers the three months ended March 31, 2019, compared with the same period in 2018. The company reports one operating segment.
Financial performance and key metrics
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Revenue | $258.9 million | $243.5 million | +6.3% |
| Operating income | $49.5 million | $47.5 million | +4.2% |
| Operating margin | 19.1% | 19.5% | (0.4) percentage points |
| Consolidated net income | $33.2 million | $41.9 million | (20.8)% |
| Diluted EPS | $0.77 | $0.98 | (21.4)% |
| Cash from operating activities | $59.0 million | $59.9 million | (1.5)% |
| Free cash flow | $40.3 million | $42.3 million | (4.7)% |
- Revenue growth was led by license-based revenue of $195.5 million, up 9.5%. Asset-based revenue declined 3.7% to $48.8 million, while transaction-based revenue increased 2.8% to $14.6 million.
- PitchBook revenue increased 54.5% to $32.3 million; Morningstar Credit Ratings revenue increased 26.7% to $9.5 million. Morningstar Investment Management revenue declined 6.3% to $26.7 million.
- General and administrative expense increased 26.7%, primarily due to higher stock-based compensation, rent, and other investments. Total operating expense increased 6.8%, faster than revenue.
- Net income was reduced by the absence of a $10.5 million gain on the sale of a product line recorded in Q1 2018. Q1 2019 also included $3.3 million of net non-operating expense versus $9.3 million of net non-operating income in the prior-year period.
- Net margin was approximately 12.8% in Q1 2019 versus approximately 17.2% in Q1 2018. The effective tax rate increased to 25.7% from 24.2%.
Balance sheet, debt, liquidity, and cash flow
- Cash, cash equivalents, and investments totaled $378.6 million at March 31, 2019, down from $395.9 million at December 31, 2018. Approximately 57% was held outside the United States.
- Long-term debt was $30.0 million, down from $70.0 million at year-end. The revolving credit facility provides borrowing capacity of $300.0 million, leaving $270.0 million available. The facility matures December 21, 2020, and the company was in compliance with its covenants.
- Q1 financing uses included $40.0 million of debt repayment, $11.9 million of dividends, $4.9 million of share repurchases, and $4.6 million for employee tax withholding on restricted stock units.
- Capital expenditures were $18.7 million, including internally developed software investments. The company capitalized $13.1 million of software development costs during the quarter.
- The company declared a quarterly dividend of $0.28 per share, payable April 30, 2019. Approximately $474.4 million remained available under the $500.0 million share-repurchase authorization.
- Adoption of the new lease standard resulted in $118.8 million of operating lease assets and $145.8 million of operating lease liabilities on the balance sheet, without a material income-statement impact.
Material changes versus the prior comparable period
- Revenue increased 6.3%, or 8.3% on an organic basis; unfavorable foreign-currency translation reduced reported revenue by approximately $4.7 million.
- U.S. revenue increased 8.7%, while international revenue was essentially flat, declining 0.3%.
- Operating income grew 4.2%, but the operating margin contracted by 0.4 percentage points because operating expenses grew faster than revenue.
- Cash from operations and free cash flow declined modestly, partly reflecting higher capital expenditures and changes in working capital, including bonus payments.
- Average assets under management and advisement increased to approximately $201.7 billion from $196.1 billion, but asset-based revenue declined because of fee pressure, slower net-flow recovery, and timing effects.
- Worldwide employees increased to 5,660 from 4,998, reflecting continued investment in the United States, India, and China.
Guidance, outlook, risks, contingencies, and unusual items
- Management stated that available cash, investments, operating cash flow, and the credit facility should be sufficient to meet operating and cash needs for at least the next 12 months. The filing does not provide formal full-year revenue or earnings guidance.
- Management expects continued capital expenditures for hardware, software, internally developed applications, and leasehold improvements. Migration of portions of the data center to the public cloud may create temporary effects on capital expenditures and operating expenses.
- Key business risks include market volatility affecting asset-based fees and credit ratings, changing investment-industry preferences, regulatory and compliance developments, technology outages and cybersecurity or data liabilities, foreign-currency exposure, competition, employee retention, acquisitions and investments, intellectual-property claims, and dependence on offshore operations.
- The company is undergoing third-party data-license audits and internal compliance reviews. Potential payments cannot be reasonably estimated for some matters, although management does not believe the outcomes will have a material adverse effect.
- Unrecognized tax benefits totaled $13.5 million before related tax effects. The company is subject to tax audits in U.S. state and local jurisdictions and certain non-U.S. jurisdictions.
- The investment portfolio is exposed to market and interest-rate risk. A 100-basis-point change in LIBOR was estimated to affect annual interest expense by approximately $0.3 million based on the quarter-end debt balance.
Important facts for investors to verify
- Whether PitchBook, Morningstar Data, and Morningstar Direct growth remains strong enough to offset weakness in asset-based revenue and advertising.
- Whether general and administrative expense, stock-based compensation, employee growth, and cloud-transition costs continue to pressure operating margins.
- The effect of market levels, fee compression, net flows, and reporting lags on asset-based revenue and related assets under management.
- Progress on cloud migration, capital expenditures, and the expected timing of associated operating efficiencies or transitional costs.
- Foreign-currency exposure and the concentration of cash and investments outside the United States.
- The results of data-license audits, tax examinations, and any related liabilities or contingencies.
- Future use of the substantial remaining share-repurchase authorization alongside dividends, debt repayment, and potential acquisitions.