Morningstar, Inc. 2017 Q2 Form 10-Q Summary
Business context and reporting period
Morningstar provides data, research, software, investment management, workplace solutions, credit ratings, and related products to individual investors, advisors, asset managers, retirement providers, and institutional investors. Revenue is generated primarily from subscription and license agreements, asset-based fees, and transaction-based services. This unaudited filing covers the three and six months ended June 30, 2017, compared with the corresponding 2016 periods.
Key financial metrics
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Revenue | $229.2 million, up 15.6% | $438.7 million, up 12.4% |
| Operating income | $46.0 million, up 3.4% | $74.4 million, down 14.2% |
| Operating margin | 20.0%, down 2.4 percentage points | 17.0%, down 5.2 percentage points |
| Net income | $46.1 million, versus $31.8 million | $64.1 million, versus $60.5 million |
| Diluted earnings per share | $1.07, versus $0.73 | $1.49, versus $1.40 |
| Cash flow from operations | $55.7 million | $102.2 million, up 23.4% |
| Free cash flow | $36.7 million, down 33.9% | $68.9 million, up 29.0% |
- Cash, cash equivalents, and investments totaled $339.6 million at June 30, 2017, including $285.6 million of cash and cash equivalents.
- Total debt was $230.0 million, consisting of borrowings under the revolving credit facility. The company had $70.0 million of remaining borrowing availability and complied with its financial covenants.
- Total assets were $1.376 billion and total equity was $739.1 million at June 30, 2017.
- Capital expenditures were $19.0 million in the second quarter and $33.3 million in the first half. Internally developed software capitalization was $23.6 million in the first half, compared with $12.4 million in 2016.
- The effective tax rate was 24.5% in the second quarter and 26.7% for the first six months, compared with 32.7% and 33.2%, respectively, in 2016.
- Quarterly dividends were $0.23 per share. The company repurchased 406,913 shares for $30.7 million during the first half and had approximately $296.4 million remaining under its $1.0 billion authorization, which expires December 31, 2017.
Material changes versus the prior comparable period
- Revenue growth benefited from the December 2016 acquisition of PitchBook Data, which contributed $15.1 million of second-quarter revenue and $28.2 million of first-half revenue. Organic revenue increased 9.2% in the second quarter and 6.2% in the first half.
- Operating expenses grew faster than revenue, increasing 19.2% in the second quarter and 20.0% in the first half. Sales and marketing expense increased 42.8% in the quarter and 43.9% in the first half, reflecting higher compensation, commissions, advertising, and PitchBook-related costs.
- First-half operating income and operating margin declined despite revenue growth, primarily because of increased investment, compensation, bonus, sales commission, depreciation, and amortization expenses.
- Management reported adjusted operating income excluding PitchBook of $47.7 million for the quarter and $81.6 million for the first half. Adjusted operating margins were 22.2% and 19.9%, respectively.
- Morningstar sold HelloWallet on June 30, 2017, recognizing a $17.5 million noncash gain. The sale was not classified as a discontinued operation.
- Net income benefited from the HelloWallet gain and related tax effects. Management stated that the gain was not taxable, and the transaction reduced the effective tax rate by 11.9 percentage points in the quarter and 8.3 percentage points for the first half.
- Product and operating indicators were mixed: Morningstar Direct licenses increased 9.6%, PitchBook Platform licenses increased 36.8%, and Workplace Solutions assets increased 20.2%, while U.S. Premium Membership subscriptions declined 0.4% and average monthly unique users declined 1.5%.
Guidance, outlook, commentary, risks, and unusual items
The filing does not provide formal numerical revenue or earnings guidance. Management expects available cash, investments, operating cash flow, and the credit facility to be sufficient for operating and cash needs for at least the next 12 months. Capital expenditures are expected to continue during 2017 for hardware, software, internally developed software, and office improvements.
- Management cited continued equity-market strength and growth in license-based products, Workplace Solutions, and Morningstar Managed Portfolios, but noted pressure from low interest rates, passive investing trends, fee sensitivity, and changing fiduciary standards.
- Key risks include technology and cybersecurity outages, protection of personal and portfolio information, data accuracy and redistribution liability, regulatory or compliance changes, acquisition execution, financial-market downturns, market-sensitive asset-based fees, foreign operations, and reliance on development facilities in China and India.
- Approximately 69% of cash, cash equivalents, and investments were held outside the United States. The company does not currently hedge foreign-currency exposure.
- A 100-basis-point change in LIBOR was estimated to affect annualized interest expense by approximately $2.3 million. A 10% adverse currency movement was estimated to reduce equity by approximately $28.1 million across disclosed currency exposures.
- The company had $19.0 million of gross unrecognized tax benefits and was under examination by various U.S. and foreign tax authorities. The filing states that current legal proceedings are not expected to have a material adverse effect.
- Morningstar elected to defer adoption of the new revenue recognition standard until January 1, 2018 and had not finalized its transition method or quantified the impact.
Important facts for investors to verify
- Whether organic growth continues after separating PitchBook acquisition effects and foreign-currency impacts.
- Whether operating-margin pressure moderates as PitchBook integration and growth investments mature.
- The sustainability of reported net income and tax-rate improvements excluding the $17.5 million HelloWallet gain and related tax effects.
- PitchBook’s revenue growth, profitability, integration costs, and final purchase-price allocation.
- Remaining debt, interest-rate exposure, covenant compliance, and available revolving-credit capacity.
- Cash repatriation and tax implications associated with the approximately 69% of cash, cash equivalents, and investments held outside the United States.
- The effect of adopting the new revenue recognition standard on reported revenue timing, deferred revenue, and disclosures.