Business Context and Reporting Period
Company: Morningstar, Inc.
Filing Type: Form 8-K (Current Report)
Date of Report: March 29, 2023
Context: This filing serves as a Regulation FD disclosure containing responses to shareholder inquiries submitted between March 1, 2023, and March 31, 2023. The document addresses operational metrics, profitability profiles, compensation structures, and capital allocation strategies for the fiscal year ended December 31, 2022, and outlook for 2023.
Key Financial Metrics
- Debt and Leverage: As of December 31, 2022, consolidated funded indebtedness was $1.1 billion. The consolidated funded indebtedness to consolidated EBITDA ratio was approximately 2.20x, well below the 3.50x covenant limit.
- Stock-Based Compensation (SBC): Total SBC related to the PitchBook plan was $37.2 million in 2022, compared to $10.6 million in 2021 and $10.0 million in 2020. This represented all Performance Share Units (PSUs) reported.
- Capital Allocation: In 2022, the company repurchased approximately 880,000 shares for $226.0 million. The average adjusted dividend payout ratio since 2018 is in the mid-20s.
- Capital Expenditures: Capex as a percentage of revenue increased to 6.9% in 2022 from 6.0% in 2021, driven by capitalized software development costs and office space investments.
- Revenue Growth: Organic revenue growth was +10.8% in 2022 compared to +17.6% in 2021.
Material Changes and Operational Updates
- Compensation Structure: The annual incentive structure for 2021 and 2022 weighted 67% on adjusted revenue and 33% on adjusted EBITDA. For 2023, the company is reverting to an equal 50/50 weighting between adjusted revenue and adjusted EBITDA to incentivize profitable growth.
- DBRS Morningstar Performance: DBRS Morningstar reported positive adjusted operating income in Q4 2022, though profit levels were significantly lower than the prior year quarter. Margins in 2022 were lower than 2019 due to market conditions and strategic investments in headcount and analytical capabilities.
- Morningstar Indexes: Organic growth slowed in Q4 2022 primarily due to declining equity markets impacting Assets Under Management (AUM) and net outflows in Q3. However, net flows for the full year remained positive.
- Acquisition Integration: Significant progress has been made in integrating Leveraged Commentary & Data (LCD) into PitchBook and Morningstar Indexes. A $3.6 million M&A earn-out accrual in Q4 2022 related to the revaluation of contingent consideration for the LCD acquisition; the full $50 million payment to S&P Global has since been made.
Guidance, Outlook, and Risks
- Outlook: Management expects stock-based compensation as a percentage of revenue to decrease in 2023 relative to 2022 due to the structure of the PitchBook incentive plan. Long-term growth rates for the global credit ratings market are expected to return to historical levels (approx. 6.3% CAGR) as the macroeconomic environment improves.
- Capital Priorities: For 2023, the company maintains a balanced approach but prioritizes debt repayment in the near-to-intermediate term following the 2022 acquisitions of Praemium and LCD.
- Risks: Key risks include cybersecurity liabilities, regulatory changes affecting credit ratings and ESG businesses, prolonged market volatility impacting asset-based fees, and the ability to integrate acquisitions efficiently.
- Guidance: The company explicitly states it does not provide specific guidance on expected growth rates or specific profitability margins for product areas like Indexes.
Investor Verification Checklist
- Verify the impact of the 2023 compensation plan shift (50% revenue/50% EBITDA) on future expense management and growth targets.
- Monitor the execution of debt paydown plans in 2023 to ensure leverage remains comfortably below the 3.50x covenant threshold.
- Track the integration timeline for LCD data and index calculations, specifically the transition of index calculations from S&P to Morningstar's in-house platform expected early next year.
- Assess the sustainability of DBRS Morningstar's margin expansion as it scales toward $350 million in revenue, noting the current lower margins compared to 2019.
- Review the renewal rates for license-based products (PitchBook and Sustainalytics), noting that roughly 30-33% of renewal value is concentrated in Q4.