Morningstar, Inc. 2023 Q3 Form 10-Q Summary
Business context and reporting period
Morningstar filed an unaudited Form 10-Q for the quarter and nine months ended September 30, 2023. The company provides investment data, research, analytics, software, asset-management and advisory solutions, indexes, and credit ratings through three reportable segments: Data and Analytics; Asset and Index Solutions; and Credit Ratings and Solutions. The segment structure was revised effective September 30, 2023, with prior periods recast for comparison.
Financial performance and key metrics
| Metric | Q3 2023 | Q3 2022 | 9M 2023 | 9M 2022 |
|---|---|---|---|---|
| Revenue | $515.5 million | $468.2 million | $1,499.9 million | $1,395.6 million |
| Operating income | $70.0 million | $22.0 million | $136.2 million | $132.3 million |
| Operating margin | 13.6% | 4.7% | 9.1% | 9.5% |
| Net income (loss) | $39.1 million | $(9.0) million | $67.6 million | $67.2 million |
| Diluted EPS | $0.91 | $(0.21) | $1.58 | $1.56 |
| Cash flow from operations | $130.7 million | $102.1 million | $178.6 million | $194.3 million |
| Free cash flow | $101.4 million | $68.4 million | $89.5 million | $100.9 million |
Q3 revenue increased 10.1%, while nine-month revenue increased 7.5%. Q3 adjusted operating income was $92.0 million, or a 17.8% adjusted operating margin, compared with $76.6 million and 16.4% in the prior-year quarter. Nine-month adjusted operating income was $213.5 million, or a 14.3% margin, down from $232.5 million and 16.7% in the prior-year period.
- Revenue mix: Q3 license-based revenue increased 12.2% to $384.5 million; asset-based revenue increased 6.2% to $71.5 million; and transaction-based revenue increased 2.1% to $59.5 million. For nine months, license-based revenue rose 14.5%, asset-based revenue rose 0.3%, and transaction-based revenue declined 18.5%.
- Segments: Q3 Data and Analytics revenue increased 11.4% to $359.4 million, with adjusted operating margin of 31.6%. Asset and Index Solutions revenue increased 9.9% to $103.2 million, with an 8.3% adjusted margin. Credit Ratings and Solutions revenue increased 2.1% to $52.9 million, but its adjusted margin fell to 2.1%.
- Nine-month segment trends: Data and Analytics revenue increased 14.0% and adjusted operating income increased 23.5%. Asset and Index Solutions revenue increased 2.7%, but adjusted operating income declined 80.7%. Credit Ratings and Solutions revenue declined 17.3% and reported a negative $1.3 million of adjusted operating income.
- Liquidity: Cash, cash equivalents, and investments totaled $363.7 million at September 30, 2023, including $325.0 million of cash and cash equivalents. Approximately 76% of cash, cash equivalents, and investments was held outside the United States.
- Debt: Total debt was $1.0555 billion, including $617.0 million under the term facility, $90.0 million under the revolving facility, and $348.5 million of 2.32% senior notes due 2030. Revolving-facility availability was $560.0 million. The company was in compliance with its debt covenants, with consolidated funded debt to consolidated EBITDA of approximately 2.0x.
- Capital returns: The company declared quarterly dividends of $0.375 per share in September 2023. It repurchased 8,484 shares for $1.4 million during the first nine months and had $498.6 million remaining under its $500 million authorization.
Material changes versus the prior comparable period
- Q3 operating income increased $48.0 million, primarily from revenue growth and lower operating expenses. The improvement benefited from substantially lower China-transition costs and lower stock-based compensation and professional fees.
- Nine-month operating income increased only $3.9 million because higher compensation, technology, sales and marketing, depreciation, and other expenses largely offset revenue growth.
- China restructuring and relocation costs declined to $2.6 million in Q3 and $15.5 million for the nine-month period, compared with $30.1 million in the respective prior-year periods. The company substantially completed the activities and expects immaterial additional expense.
- Headcount was 11,566 at September 30, 2023, down 1.3% year over year and 4.6% sequentially. Targeted reorganizations affected Sustainalytics, Morningstar Wealth, and DBRS Morningstar.
- Credit Ratings and Solutions remained under pressure, particularly from weak U.S. commercial mortgage-backed securities issuance and lower residential mortgage-backed securities activity.
- The company’s effective tax rate for the first nine months declined to 21.8% from 30.9%, primarily because of $13.7 million of tax benefits from a retroactive tax election affecting 2021 and 2022.
- Morningstar completed the termination of its Japan brand license and reduced its ownership in Wealth Advisors to 13.2%. The transaction generated $26.2 million of net proceeds and an $18.4 million pretax gain, while requiring $59.9 million of cash payments.
Guidance, outlook, commentary, risks, and unusual items
The filing does not provide a specific quantitative full-year revenue or earnings guidance range. Management stated that available cash, investments, operating cash flow, and the amended credit facility should be sufficient to meet operating and cash needs for at least the next 12 months.
- Management expects continued capital expenditures for hardware, third-party and internally developed software, leasehold improvements, cloud migration, and software-as-a-service initiatives. Certain systems may operate in parallel during the migration.
- Q3 revenue growth was supported by strong demand across Data and Analytics, including PitchBook, Morningstar Data, Morningstar Direct, and Sustainalytics. Sustainalytics growth moderated because of softer ESG demand in portions of North America.
- Average assets under management and advisement were $263.5 billion in Q3, up 7.1% year over year, while nine-month average AUMA was essentially flat at $255.3 billion.
- DBRS entered into two SEC settlements related to electronic communications recordkeeping and former CMBS ratings methodologies. Morningstar accrued $8.0 million of penalties in 2023; $6.0 million was paid in October 2023.
- Key risks include financial-market volatility affecting asset-based and ratings revenue, cybersecurity and data protection, regulatory scrutiny of ratings, ESG, advisory and index activities, artificial intelligence risks, acquisition integration, employee retention, foreign currency movements, leverage and interest rates, tax audits, intellectual-property claims, and litigation or data-license audits.
- A 100-basis-point change in SOFR was estimated to affect annualized interest expense by approximately $7.1 million. The company does not currently hedge its foreign-currency risk.
- Data-vendor audits and regulatory or ratings matters could result in payments, penalties, restrictions, or litigation, although management does not currently expect these matters to have a material adverse effect.
Most important facts for investors to verify
- Whether Data and Analytics growth remains sufficient to offset continued weakness in Credit Ratings and Solutions and slower ESG demand.
- Whether the nine-month decline in adjusted operating margin reverses as China-transition costs fade, or whether compensation, technology, and investment spending remain elevated.
- The sustainability of cash generation after interest expense, the Japan transaction payments, LCD-related payments, capital expenditures, dividends, and debt service.
- Compliance with debt covenants and the effect of SOFR changes on interest expense and liquidity.
- The financial and operational consequences of the DBRS SEC settlements and any further regulatory scrutiny.
- Whether the announced workforce reductions and other reorganizations achieve expected cost savings without impairing growth, product development, or employee retention.
- The effect of foreign currency movements, international cash concentration, market values, and client asset flows on revenue, earnings, and equity.