Morningstar, Inc. Form 10-Q Summary
Business Context and Reporting Period
Morningstar, Inc. provides investment data, research, analytics, ratings, software, index, asset-management, workplace, and advisory solutions. The filing reports unaudited results for the three and six months ended June 30, 2023, compared with the corresponding 2022 periods. Morningstar reports one operating segment.
Key Financial Metrics
| Metric | Q2 2023 | Q2 2022 | Six Months 2023 | Six Months 2022 |
|---|---|---|---|---|
| Revenue | $504.7 million | $470.4 million | $984.4 million | $927.4 million |
| Operating income | $41.7 million | $53.9 million | $66.2 million | $110.3 million |
| Operating margin | 8.3% | 11.5% | 6.7% | 11.9% |
| Consolidated net income | $36.1 million | $30.1 million | $28.5 million | $76.2 million |
| Diluted EPS | $0.84 | $0.70 | $0.67 | $1.77 |
| Cash provided by operating activities | $24.5 million | $68.7 million | $47.9 million | $92.2 million |
| Free cash flow | $(5.8) million | $37.0 million | $(11.9) million | $32.5 million |
Adjusted operating income, excluding intangible amortization, M&A-related items, and China transition costs, was $69.7 million in Q2 and $121.5 million for the first six months. Adjusted operating margin was 13.8% and 12.3%, respectively; these are non-GAAP measures.
At June 30, 2023, cash, cash equivalents, and investments totaled $378.2 million, including $343.3 million of cash and cash equivalents. Total debt was $1.154 billion, consisting primarily of $805.0 million outstanding under the amended 2022 Credit Agreement and $348.5 million of 2.32% senior notes due 2030. Revolving-credit availability was $470.0 million, and the company was in compliance with its debt covenants. Consolidated funded indebtedness to EBITDA was approximately 2.5x.
The board approved a quarterly dividend of $0.375 per share, or approximately $16.0 million, payable July 31, 2023. Only $1.4 million of shares were repurchased during the first six months, leaving $498.6 million authorized for future repurchases.
Material Changes Versus the Prior Comparable Period
- Revenue increased 7.3% in Q2 and 6.1% year to date. Organic revenue growth was 5.1% and 4.0%, respectively, after excluding acquisitions and foreign-currency effects.
- License-based revenue increased 14.8% in Q2 and 15.7% year to date, led by PitchBook, Morningstar Sustainalytics license products, Morningstar Data, and Morningstar Direct.
- Asset-based revenue declined 0.4% in Q2 and 2.6% year to date, primarily because Investment Management weakness offset growth in Morningstar Indexes and Workplace Solutions.
- Transaction-based revenue declined 18.5% in Q2 and 26.4% year to date, reflecting reduced U.S. commercial-mortgage-backed securities ratings activity, weaker Sustainalytics second-party-opinion activity, and lower Morningstar.com advertising revenue.
- Operating expenses rose 11.2% in Q2 and 12.4% year to date, outpacing revenue growth. Higher compensation, severance, depreciation, amortization, rent, and marketing costs were significant contributors.
- Operating margin contracted 3.2 percentage points in Q2 and 5.2 percentage points year to date. Higher interest expense also reduced non-operating results, with net interest expense increasing to $14.1 million in Q2 and $27.4 million year to date.
- Net income increased in Q2 despite lower operating income, primarily because of a $13.7 million tax benefit from a retroactive tax election. Year-to-date net income declined substantially due to lower operating income, higher interest expense, and a $11.8 million net expense from an equity-method transaction.
- Cash flow weakened. Year-to-date operating cash flow fell 48.0%, and free cash flow changed from positive $32.5 million to negative $11.9 million.
Outlook, Commentary, Risks, and Unusual Items
- Management expects the reduction and relocation of Shenzhen, China operations to be substantially complete by the end of the third quarter of 2023, with lower ongoing run-rate costs after the transition. Remaining accrued severance was $14.2 million at June 30, 2023 and was expected to be substantially paid through Q3.
- China transition costs were $7.3 million in Q2 and $12.9 million year to date. Management also identified $4.0 million of Q2 and year-to-date severance costs related to other reorganizations.
- Management stated that cash, investments, operating cash generation, and available credit are expected to meet operating and cash needs for at least the next 12 months. Approximately 74% of cash, cash equivalents, and investments were held outside the United States.
- Morningstar paid $59.9 million to terminate its Morningstar Japan brand license and received $26.2 million from tendering Wealth Advisors shares. The transaction produced an $18.4 million pretax gain, while related termination costs and other effects were reported in the equity-method transaction line.
- The company paid $50.0 million in February 2023 to resolve contingent consideration related to the LCD acquisition.
- DBRS received a Wells notice from SEC Enforcement staff concerning alleged recordkeeping and disclosure-related matters. Morningstar recorded an immaterial accrual and stated that it did not expect a material adverse effect, although the matter remains unresolved.
- Key risks include financial-market and economic weakness affecting asset-based and ratings revenue, leverage and variable-rate interest expense, cybersecurity and data protection, regulatory scrutiny of ratings and ESG activities, artificial-intelligence risks, acquisition integration, foreign-currency exposure, talent retention, intellectual-property claims, and third-party data-license audits.
- No formal financial guidance is provided in the filing. The filing states that a 100-basis-point increase in SOFR would increase annualized interest expense by approximately $8.1 million based on June 30 balances.
Important Facts for Investors to Verify
- Whether license-based growth can offset continued weakness in transaction-based revenue, particularly DBRS Morningstar and Sustainalytics second-party opinions.
- Whether the Shenzhen transition is completed by the end of Q3 and whether expected cost savings materialize without further restructuring charges.
- The sustainability of operating margins after elevated compensation, amortization, transition, and reorganization costs.
- Debt reduction, interest-rate sensitivity, covenant compliance, and the company’s ability to rebuild positive free cash flow.
- The ultimate resolution and potential financial impact of the SEC Wells notice involving DBRS.
- The extent to which the Q2 tax benefit and other equity-method transaction items affect comparability with future periods.
- Foreign-currency exposure, international cash concentration, and potential restrictions or costs associated with repatriating foreign earnings.