Business Context and Reporting Period
This Form 8-K, filed on December 22, 2022, by Morningstar, Inc. (MORN), serves as a Regulation FD disclosure containing responses to investor inquiries received through November 30, 2022. The filing addresses operational metrics, cost structures, and strategic outlooks for the company's financial technology, credit ratings, and ESG data businesses.
Key Financial Metrics and Operational Data
- Operating Margin: Declined from 14.7% for the first nine months of 2021 to 9.5% for the first nine months of 2022, a contraction of 5.2 percentage points.
- Cost Structure: Employee-related costs (compensation, benefits, commissions, stock-based compensation) accounted for roughly two-thirds of the overall cost structure in 2021 and remained consistent through the first nine months of 2022.
- Headcount: Headcount increased by 26% in the third quarter of 2022. The company plans to slow headcount growth in 2023, except in fastest-growing product areas and Wealth Management.
- Turnover: The trailing 12-month average turnover for permanent, full-time employees was 18.5% as of December 2021, up from 11.8% in 2020. The annualized rate through the first 11 months of 2022 was similar to the full-year 2021 rate.
- Capital Allocation: The company announced a 4.2% increase in its quarterly dividend payable in 2023 and a new $500 million share repurchase program. The average adjusted payout ratio since 2018 is in the mid-20s.
Material Changes Versus Prior Period
The primary material change is the significant compression in operating margins driven by specific cost increases. The filing details the drivers of the 5.2 percentage point margin decline:
- Compensation and Benefits: Contributed a -7.4 percentage point impact.
- Stock-Based Compensation: Contributed a -2.2 percentage point impact.
- China Operations Transition: Severance and personnel expenses associated with the reduction and shift of China operations contributed a -2.4 percentage point impact.
- Revenue Growth: Revenue growth provided a positive 11.6 percentage point impact on the margin calculation, partially offsetting cost increases.
- Other Costs: Professional fees (-1.8%), sales commissions (-1.4%), and infrastructure costs (-1.4%) also contributed to the decline.
Guidance, Outlook, and Management Commentary
Pricing Strategy
Management indicated that pricing is a priority focus for 2023 due to the inflationary environment. The company is implementing higher-than-typical annual price increases for license-based products, ranging from mid-single-digits to low-double-digits. Price increases are more difficult in asset-based fee areas due to industry-wide fee compression.
Business Segment Outlook
- Sustainalytics: Net new sales to institutional investors increased more than 60% year-to-date through September, compared to 10% growth for corporates. The company views both segments as equally important for future growth.
- DBRS Morningstar: The company does not observe a trend of corporates using fewer rating agencies in its active markets. It holds a leading position in Canada and is growing in Europe, while facing competition from Moody's and S&P in the U.S. public investment-grade sector.
- PitchBook: Viewed as critical for future growth due to the convergence of private and public markets. The company is bundling PitchBook with public equity data, ESG ratings, and LCD data. The estimated Total Addressable Market (TAM) is $4.9 billion.
Risks and Contingencies
Forward-looking statements highlight risks including cybersecurity liability, regulatory changes, failure to recruit/retain talent in an inflationary wage environment, operational disruptions, and the impact of geopolitical fragmentation. Specific attention is drawn to the transition of China operations, expected to be substantially complete by the end of the third quarter of 2023.
Investor Verification Checklist
- Verify the full-year 2022 employee turnover rate in the upcoming Enterprise Sustainability Report.
- Monitor the execution of the China operations transition and associated costs through Q3 2023.
- Track the realization of price increases in license-based products versus asset-based fee compression in 2023.
- Review the 2022 proxy statement for detailed calculations of adjusted revenue and adjusted EBITDA used in the bonus plan.
- Assess the integration progress of PitchBook with Morningstar's public equity and ESG data offerings.