Morningstar, Inc. 2019 Q2 Form 10-Q Summary
Business context and reporting period
Morningstar provides investment data, research, analytics, software, investment management, workplace solutions, indexes, and credit ratings. Revenue is generated primarily from recurring license and subscription agreements, asset-based fees, and transaction-based services. This unaudited Form 10-Q covers the three and six months ended June 30, 2019, compared with the corresponding 2018 periods.
Key financial metrics
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Revenue | $273.9 million, up 8.5% | $532.8 million, up 7.4% |
| Operating income | $50.8 million, down 5.2% | $100.3 million, down 0.8% |
| Operating margin | 18.5%, versus 21.2% | 18.8%, versus 20.4% |
| Net income | $42.1 million, versus $41.8 million | $75.3 million, versus $83.7 million |
| Diluted EPS | $0.98, versus $0.97 | $1.75, versus $1.95 |
| Operating cash flow | $87.2 million, up 24.9% | $146.2 million, up 12.7% |
| Free cash flow | $68.9 million, up 33.0% | $109.2 million, up 16.0% |
Revenue growth was led by license-based revenue, which increased 9.0% in the quarter and 9.2% year to date. Asset-based revenue increased 8.0% in the quarter and 2.1% year to date, while transaction-based revenue increased 5.2% and 3.9%, respectively. Organic revenue growth, excluding foreign currency effects and other specified items, was 10.0% in the quarter and 9.2% year to date.
Cash, cash equivalents, and investments totaled $413.9 million at June 30, 2019, including $383.8 million of cash and cash equivalents and $30.1 million of investments. Total debt was $15.0 million, with $285.0 million of availability under the then-existing credit agreement. The company was in compliance with its financial covenants. Current liabilities were $381.4 million versus current assets of $619.9 million.
Quarterly and year-to-date dividends were $0.28 and $0.56 per share, respectively. Approximately $474.4 million remained available under the $500.0 million share repurchase authorization.
Material changes versus the prior comparable period
- Revenue increased, but operating income and margins declined because operating expenses grew faster than revenue.
- Sales and marketing expense increased 16.0% in the quarter, and general and administrative expense increased 22.2%, reflecting higher compensation, commissions, rent, professional fees, and stock-based compensation.
- Worldwide headcount increased to 5,829 from 5,023 a year earlier, reflecting investment in product development, data operations, sales, and support.
- PitchBook revenue increased 47.5% in the quarter and 50.8% year to date; PitchBook platform licenses increased 61.8% year over year.
- Morningstar Credit Ratings revenue increased 23.3% in the quarter and 25.6% year to date, supported by higher structured-finance issuance activity.
- Morningstar.com advertising revenue declined 14.8% in the quarter and 19.4% year to date because of lower client marketing spending.
- Foreign currency movements reduced revenue by approximately $3.8 million in the quarter and $8.5 million year to date.
- Cash flow improved despite lower net income, supported in part by a $37.2 million increase in deferred revenue during the first six months.
- The company adopted the lease standard, Topic 842, on January 1, 2019. At June 30, operating lease assets were $111.8 million and lease liabilities were $139.0 million; the adoption did not materially affect net income.
Guidance, outlook, risks, contingencies, and unusual items
The filing does not provide formal quantitative revenue or earnings guidance. Management expects available cash, investments, operating cash flow, and borrowing capacity to meet operating and cash needs for at least the next 12 months. Capital expenditures are expected to continue in 2019 for hardware, software, internally developed applications, and leasehold improvements. The company is migrating portions of its infrastructure to public cloud and expects transitional effects on capital expenditures and operating expenses.
On July 2, 2019, after the reporting date, Morningstar completed its acquisition of DBRS for $669.0 million. The acquisition was financed with cash and a new five-year senior credit agreement with up to $750.0 million of capacity, including a $450.0 million term loan and a $300.0 million revolving facility. Aggregate borrowings under the new agreement were $610.0 million at closing. This transaction materially changes the company’s leverage and interest expense profile after quarter-end.
The company signed an agreement to divest an equity interest in an unconsolidated investment, expected to close in the third quarter of 2019. No significant acquisitions were completed during the second quarter.
Key risks include market volatility affecting asset-based fees and credit ratings, regulatory and compliance risks in investment advisory and ratings activities, cybersecurity and data privacy exposure, technology outages and cloud migration execution, intellectual property and data-licensing claims, foreign currency exposure, employee retention, and the integration and performance of acquisitions. The company is undergoing third-party data-license audits and internal reviews; potential payments cannot be reasonably estimated for some matters, although management does not expect a material adverse effect.
Unrecognized tax benefits totaled $13.7 million at June 30, 2019, and the company was subject to tax audits in multiple jurisdictions. No material changes were reported to the risk factors in the 2018 Form 10-K.
Important facts for investors to verify
- Post-quarter-end debt levels, leverage ratios, covenant compliance, and interest expense following the DBRS acquisition.
- DBRS integration progress, purchase accounting, goodwill, intangible assets, and any acquisition-related charges.
- Whether operating expense growth moderates enough to restore operating margins.
- Sustainability of PitchBook, Morningstar Data, Morningstar Direct, and Credit Ratings growth.
- Trends in advertising revenue, asset-based fees, market-linked assets, and international revenue.
- Cash conversion, deferred revenue trends, capital expenditures, and free cash flow after the acquisition.
- Outcomes of data-license audits, tax examinations, and the planned divestiture of the unconsolidated investment.