Morningstar, Inc. — Q1 2023 Form 10-Q Summary
Business context and reporting period
Morningstar provides investment data, research, ratings, analytics, software, investment management, and related services to institutions, advisors, and individual investors. The filing covers the three months ended March 31, 2023, compared with the three months ended March 31, 2022. The financial statements are unaudited and prepared under U.S. GAAP.
Key financial metrics
| Metric | Q1 2023 | Q1 2022 | Change |
|---|---|---|---|
| Revenue | $479.7 million | $457.0 million | 5.0% |
| Operating income | $24.5 million | $56.4 million | (56.6%) |
| Operating margin | 5.1% | 12.3% | (7.2) percentage points |
| Consolidated net income (loss) | $(7.6) million | $46.1 million | Declined to a loss |
| Diluted EPS | $(0.18) | $1.06 | Declined to a loss |
| Cash provided by operating activities | $23.4 million | $23.5 million | (0.4%) |
| Capital expenditures | $29.5 million | $28.0 million | 5.4% |
| Free cash flow | $(6.1) million | $(4.5) million | Lower by $1.6 million |
Revenue growth was led by license-based revenue, which increased 16.7% to $364.0 million. Asset-based revenue declined 4.7% to $65.3 million, and transaction-based revenue declined 34.2% to $50.4 million. Organic revenue increased 2.8% to $469.8 million after excluding acquisitions and foreign-currency effects.
Cost of revenue increased 14.4%, sales and marketing increased 32.2%, and depreciation and amortization increased 19.1%. Adjusted operating income, a non-GAAP measure, was $51.8 million versus $82.5 million, and adjusted operating margin was 10.8% versus 18.1%.
Liquidity, debt, and balance sheet
- Cash, cash equivalents, and investments totaled $385.4 million at March 31, 2023, down from $414.6 million at December 31, 2022.
- Total debt was $1.1315 billion, consisting primarily of $633.0 million under the term facility, $150.0 million under the revolving facility, and $348.5 million of 2.32% senior notes due 2030.
- Borrowing availability under the amended revolving credit facility was $500.0 million.
- The company reported compliance with its debt covenants; consolidated funded indebtedness to consolidated EBITDA was approximately 2.5x.
- Approximately 68% of cash, cash equivalents, and investments was held outside the United States.
- Management stated that available liquidity, operating cash flow, and credit facilities should be sufficient for operating and cash needs for at least the next 12 months.
Material changes versus the prior comparable period
- Revenue increased $22.7 million, but operating expenses increased $54.6 million, reducing operating income by $31.9 million.
- Operating results were pressured by weak global credit issuance and lower asset values, affecting DBRS Morningstar, transaction-based revenue, Investment Management, and Workplace Solutions.
- PitchBook revenue increased 24.8%; Morningstar Sustainalytics increased 10.5%; Morningstar Data increased 6.3%; and Morningstar Direct increased 7.0%.
- DBRS Morningstar revenue declined 32.4%, reflecting weak credit-market activity. Recurring revenue represented 55.4% of DBRS Morningstar revenue, compared with 36.0% in the prior-year quarter.
- Average assets under management and advisement declined 6.8% to approximately $247.0 billion.
- Worldwide headcount increased 23.6% to approximately 12,411, primarily reflecting hiring in Sustainalytics and PitchBook and other growth initiatives.
- The company continued reducing and relocating its Shenzhen operations. First-quarter costs related to the transition totaled $5.6 million, and the activities are expected to be substantially complete by the end of the third quarter of 2023.
Outlook, unusual items, risks, and contingencies
- Morningstar provided no explicit quantitative revenue or earnings guidance in the filing.
- The company expects lower ongoing costs after completing the Shenzhen transition, but temporary severance, transformation, duplicate staffing, and asset-impairment costs will continue through the transition. Accrued severance was $16.2 million at March 31, 2023 and was expected to be paid through the third quarter.
- The first quarter included a $61.4 million expense related to terminating the Morningstar Japan brand license, partially offset by an $18.4 million gain on shares tendered to SBI and a $31.2 million unrealized gain on the remaining investment. These items contributed materially to the reported net loss.
- Morningstar paid $50.0 million in February 2023 to resolve contingent consideration related to the Leveraged Commentary & Data acquisition. It also paid $59.9 million in April 2023 under the Japan termination agreement.
- The board authorized a $500.0 million share-repurchase program effective January 1, 2023; no shares had been repurchased through March 31, 2023. The quarterly dividend was $0.375 per share.
- Principal risks include financial-market and credit-cycle weakness, asset-based revenue volatility, leverage and variable interest rates, cybersecurity and data protection, regulatory scrutiny of ratings and ESG activities, acquisition integration, employee retention, foreign exchange, tax complexity, and intellectual-property matters.
- The company disclosed potential exposure from third-party data audits and regulatory, legal, and commercial matters but did not expect these matters to have a material adverse effect. Loss amounts for data audits generally could not be reasonably estimated.
- A 100-basis-point change in SOFR was estimated to affect annualized interest expense by approximately $7.8 million.
Important facts for investors to verify
- Whether license-based growth can offset continued weakness in transaction-based and asset-based revenue.
- The timing and realized savings from completing the Shenzhen restructuring and the remaining transition costs.
- Debt reduction, interest-rate sensitivity, covenant headroom, and the use of the $500.0 million revolving capacity.
- The sustainability of cash flow and the timing of a return to positive free cash flow.
- The valuation and earnings impact of the remaining Wealth Advisors investment after the reduction in ownership to 13.2%.
- Progress under the $500.0 million share-repurchase authorization and the company’s ability to sustain dividends while carrying significant debt.