Morningstar, Inc. 2020 Q1 Form 10-Q Summary
Business context and reporting period
Morningstar provides investment data, research, analytics, software, investment management, workplace solutions, and credit ratings services. This unaudited Form 10-Q covers the three months ended March 31, 2020, compared with the three months ended March 31, 2019. Results include the acquired DBRS business, consolidated beginning July 2, 2019.
Financial results and key metrics
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Revenue | $324.0 million | $258.9 million | +25.1% |
| Operating income | $44.5 million | $49.5 million | -10.1% |
| Operating margin | 13.7% | 19.1% | -5.4 percentage points |
| Net income | $23.9 million | $33.2 million | -28.0% |
| Diluted EPS | $0.55 | $0.77 | -28.6% |
| Cash from operations | $48.7 million | $59.0 million | -17.5% |
| Free cash flow | $33.6 million | $40.3 million | -16.6% |
- Revenue growth included $37.2 million from DBRS Morningstar and a $2.0 million unfavorable foreign-currency impact. Organic revenue increased 11.6%.
- License-based revenue increased 10.5% to $216.0 million; asset-based revenue increased 17.2% to $57.2 million; transaction-based revenue increased to $50.8 million from $14.6 million, principally due to DBRS Morningstar.
- Adjusted operating income, excluding intangible amortization and M&A-related expenses, was $61.4 million, up 12.2%; adjusted operating margin was 18.9%, down from 21.1%.
- Operating expenses rose 33.5% to $279.5 million. Increases reflected DBRS-related costs, higher compensation, professional fees, integration activity, and $9.2 million of additional amortization.
- The effective tax rate was 26.2%, compared with 25.7% in the prior-year quarter.
- Cash, cash equivalents, and investments totaled $348.8 million at March 31, 2020, including $322.5 million of cash and cash equivalents.
- Total debt was $530.4 million, consisting primarily of a $440.4 million term facility and $90.0 million drawn on the revolving facility. Borrowing availability under the $300.0 million revolving facility was $210.0 million.
- The company paid $12.9 million in dividends and repurchased 176,925 shares for $20.0 million during the quarter.
Material changes versus the prior comparable period
- DBRS Morningstar materially increased revenue and operating expenses, but associated amortization, integration, regulatory, and compensation costs pressured GAAP profitability.
- Net income and diluted EPS declined despite higher revenue, primarily because expenses and non-operating costs grew faster than revenue.
- Non-operating expense increased to $11.3 million from $3.3 million, including higher interest expense and foreign-currency losses.
- Cash from operations declined partly because the quarter included $82.8 million of bonus payments, including the addition of DBRS Morningstar to the bonus payout.
- Comprehensive income changed to a loss of $20.3 million from income of $38.0 million, primarily due to a $40.4 million foreign-currency translation loss and investment losses.
- Goodwill declined to $1.013 billion from $1.039 billion at year-end, primarily from foreign-currency translation; no impairment loss was recorded.
Guidance, outlook, risks, contingencies, and unusual items
- Management did not provide a clear quantitative full-year revenue or earnings outlook in the filing. It stated that the full impact of COVID-19 could not reasonably be estimated.
- COVID-19 could delay or reduce customer purchases, implementations, renewals, and spending; lower asset-based revenue through market declines; and reduce credit-rating revenue through lower debt issuance. The filing notes a lag between market movements and asset-based revenue.
- Morningstar transitioned its global workforce to remote work and implemented business-continuity measures. Management reported no material interruption to core data, research, and ratings services at the filing date.
- Management expected available cash, operating cash flow, and credit capacity to satisfy operating and cash needs for at least the next 12 months, while acknowledging pandemic-related uncertainty.
- On April 1, 2020, Morningstar completed its acquisition of PlanPlus Global. On April 21, it agreed to acquire the remaining approximately 60% of Sustainalytics for approximately EUR55 million at closing, plus contingent payments based on 2020 and 2021 revenue; closing was expected in early Q3 2020.
- Morningstar also secured a commitment for a 364-day senior revolving facility of up to $50.0 million to help finance the Sustainalytics acquisition.
- MCR had a proposed SEC settlement involving a $3.5 million civil penalty, accrued at December 31, 2019, subject to Commission approval. A separate SEC enforcement recommendation relating to former commercial mortgage-backed securities ratings methodology remained pending.
- Third-party data-license audits and reviews could require payments for prior usage, but the company could not reasonably estimate potential losses and did not expect a material adverse effect.
- The company was in compliance with debt covenants at March 31, 2020. A 100-basis-point change in LIBOR was estimated to affect annual interest expense by approximately $5.3 million.
Facts investors should verify
- COVID-19 effects on renewals, customer demand, asset-based fees, credit-rating issuance, receivables, and future margins.
- Integration costs, amortization, synergies, and covenant headroom following the DBRS acquisition.
- Funding, closing conditions, contingent consideration, and leverage implications of the Sustainalytics acquisition and new $50.0 million facility.
- Foreign-currency exposure, including the substantial first-quarter translation loss and the company’s lack of currency hedging.
- Progress and potential financial impact of SEC matters involving Morningstar Credit Ratings and ongoing data-license audits.
- Whether the company continues share repurchases and dividends while managing pandemic uncertainty and acquisition-related debt.