Business Context and Reporting Period
Company: Morningstar, Inc.
Filing Type: Form 8-K (Current Report)
Date of Report: April 5, 2023
Reporting Period: This filing serves as a Regulation FD disclosure containing written responses to shareholder inquiries submitted between March 1, 2023, and March 31, 2023. The financial data discussed primarily covers the full year 2022 and comparisons to 2021 and 2020.
Key Financial Metrics
Operating Expenses (2022 vs. 2021):
- G&A Expenses: Increased $82.0 million, rising from 18.7% of revenues in 2021 to 21.4% in 2022. Excluding China operation shifts, this would have been 19.5%.
- Sales & Marketing Expenses: Increased $81.7 million, rising from 16.2% of revenues in 2021 to 19.1% in 2022.
- Compensation Costs: Total compensation and related benefits increased $97.5 million in 2022. This included a $145.8 million increase in salaries, benefits, and severance, partially offset by a $48.3 million decrease in bonus expense.
- FCF Conversion: Declined from 96% of Adjusted Operating Income in 2021 to 56% in 2022. Adjusted for M&A expenses and earnouts, conversion declined from 105% in 2021 to 75% in 2022.
- Capital Expenditures: Increased by $27 million (27%) year-over-year due to software development and hybrid work environment investments.
- 2022 Total: $136.4 million (57.6% of total DBRS revenue).
- 2021 Total: $178.2 million (65.7% of total DBRS revenue).
- Breakdown (2022): Structured Finance ($103.7M) and Fundamental ($32.7M).
- Turnover Rate: 18.9% in 2022 (unchanged from 18.5% in 2021).
- Advisor Workstation Renewal Rate: Dropped to 89% in 2022 from 92% in 2021.
Material Changes Versus Prior Period
Expense Growth Drivers:
- G&A Increases: Driven by $25.8 million in severance related to China operations, $32.1 million in stock-based compensation (PitchBook bonus overachievement), and $17.2 million in professional fees (including legal fees for the Sustainalytics investigation).
- Sales & Marketing Increases: Driven by $37.7 million in compensation (headcount growth in PitchBook and Sustainalytics), $17.5 million in sales commissions, and $10.7 million in advertising/marketing.
- Working Capital: Cash generated from operating assets/liabilities declined by approximately $75 million, largely due to a swing in accrued compensation and deferred commissions from a $58.0 million source in 2021 to a $37.5 million use in 2022.
- Interest Payments: Increased by approximately $18 million due to rising rates and higher debt balances from the LCD acquisition.
- DBRS: Transaction-based revenue declined from $178.2 million in 2021 to $136.4 million in 2022.
- Morningstar Direct: Accelerated to 12% organic growth in Q4 2022, driven by new logos, low churn, and pricing adjustments.
- Advisor Workstation: Revenue grew 3.8% (4.1% organic) despite a 300 bps decline in renewal rates, attributed to churn in the individual advisor segment during migration to new packages.
Guidance, Outlook, and Risks
Management Commentary and Outlook:
- Cost Control: Management is slowing headcount growth broadly across the company. They expect sales and marketing/G&A cost growth to slow relative to the 2022 pace.
- FCF Expectations: No formal guidance provided. Management expects FCF to increase in proportion to profit growth in 2023, aided by lower bonus payouts based on 2022 performance compared to 2021 payouts.
- Profitability Targets: Management does not provide specific margin targets but aims to drive margins closer to historical peaks (e.g., the 23% Adjusted EBIT margin seen in 2020) over time, barring significant M&A activity.
- ROIC: Targeting cash-on-cash returns in the mid-teens and ROIC well above the cost of capital.
- Regulatory/Legal: Risks include compliance failures, regulatory action, and liability related to the independent investigation of Morningstar Sustainalytics research practices.
- Market Conditions: Prolonged volatility or downturns affecting the financial sector could impact revenue from asset-based fees and credit ratings.
- Operational: Risks related to cybersecurity, data protection, and the ability to integrate acquisitions (Sustainalytics, LCD, Praemium) efficiently.
- Human Capital: Challenges in recruiting and retaining qualified employees, particularly in ESG (Sustainalytics) and credit ratings (DBRS).
Key Facts for Investor Verification
- Expense Allocation: Verify the sustainability of G&A and Sales & Marketing expense ratios (21.4% and 19.1% respectively in 2022) as management slows headcount growth.
- FCF Recovery: Monitor Q1 and Q2 2023 cash flow statements to confirm the expected improvement in FCF conversion due to lower bonus payouts and working capital normalization.
- Sustainalytics Integration: Track the timeline for Morningstar Sustainalytics revenue growth to outpace headcount growth, as this area currently exerts the largest negative impact on margins.
- DBRS Revenue Mix: Observe the trend in transaction-based revenue for DBRS Morningstar, which declined significantly in 2022, to assess the impact of lower issuance volumes.
- Advisor Workstation Migration: Verify the long-term impact of the 300 bps renewal rate decline on total revenue as customers migrate to Morningstar Direct.