Business Context and Reporting Period
This Form 8-K, filed on October 4, 2019, by Morningstar, Inc., serves as a Regulation FD disclosure containing responses to investor inquiries regarding the company's acquisition of DBRS. The filing addresses financial metrics and operational details related to the transaction, with specific data points referencing the six months ended June 30, 2019, and the fiscal years ended November 30, 2018, and December 31, 2018.
Key Financial Metrics
- DBRS Operating Margins: Reported at 5.9% for the first half of 2019 (1H19) on a GAAP basis. Excluding purchase accounting amortization, the adjusted operating margin was 19.7% for 1H19 and 25.3% for the full year ended November 30, 2018.
- Pro Forma Earnings Per Share (EPS): Diluted EPS was $1.66 for the six months ended June 30, 2019, and $4.18 for the year ended December 31, 2018. Morningstar's historical results for these periods were $1.75 and $4.25, respectively.
- Adjusted Pro Forma EPS: Excluding non-cash intangible amortization, pro forma diluted EPS would be $1.85 for the six months ended June 30, 2019, and $4.49 for the year ended December 31, 2018.
- DBRS Cash Flow: Operating cash flow was CAD $34.9 million for the 12 months ended November 30, 2018, and CAD $42.6 million for the prior year. Free cash flow was CAD $27.2 million and CAD $39.2 million for the respective periods.
- Effective Tax Rate: The consolidated effective tax rate was 16.3% for the full year ended December 31, 2018, and 22.5% for the six months ended June 30, 2019.
- Debt and Interest: Estimated interest expense and amortization of debt issuance fees for the six months ended June 30, 2019, totaled $10.7 million (approximately $5.3 million per quarter).
Material Changes and Acquisition Impact
The primary material change discussed is the acquisition of DBRS, which impacts financial reporting through purchase accounting adjustments. The filing clarifies that the apparent dilution in pro forma EPS and lower operating margins are largely driven by non-cash intangible asset amortization ($33.8 million annually) and incremental interest expense from debt financing. Management notes that excluding these non-cash items reveals accretion of $0.10 per share for the six months ended June 30, 2019, and $0.24 per share for the year ended December 31, 2018.
Guidance, Outlook, and Risks
Outlook and Strategy: Management views the acquisition through a "growth lens," emphasizing DBRS's strong cash generation rather than relying solely on synergies for success. While cost-saving opportunities are planned during integration, the deal is not solely dependent on them. The company anticipates a go-forward effective tax rate in the mid-20s, aligning with the 22.5% rate seen in the most recent six-month period.
Risks and Contingencies: The filing includes a standard caution regarding forward-looking statements, listing risks such as fiduciary liability, brand reputation, technology failures, regulatory changes, and the failure of acquisitions to meet expectations. Specific to the acquisition, risks include the integration of operations and the impact of debt repayment on future interest expenses.
Investor Verification Checklist
- Verify the $288.2 million valuation of DBRS intangible assets and the resulting $33.8 million annual amortization expense.
- Confirm the distinction between GAAP operating margins (5.9%) and adjusted operating margins (19.7%) for DBRS in 1H19.
- Monitor the actual effective tax rate in future quarters to see if it stabilizes near the mid-20s as projected.
- Track the pace of debt repayment to determine if the $5.3 million quarterly interest expense estimate remains accurate.
- Review subsequent filings for updates on the integration of DBRS and the realization of anticipated cost synergies.