Business Context and Reporting Period
This Form 8-K, filed on November 8, 2019, by Morningstar, Inc. (MORN), serves as a Regulation FD disclosure containing responses to investor inquiries regarding the company's third-quarter 2019 performance. The filing focuses heavily on the integration of the DBRS acquisition, capital allocation strategies, and segment-specific growth dynamics.
Key Financial Metrics
- Debt and Liquidity: As of September 30, 2019, outstanding debt was $545 million. The company deployed $78 million of free cash flow and excess cash toward debt payments in Q3 2019. Total cash and investment balance was $353 million, with 72% held outside the U.S.
- Cash Flow: Morningstar generated $85.6 million in free cash flow for Q3 2019. Free cash flow increased 42.2% year-over-year and 26.2% year-to-date.
- Revenue Mix: Transaction-based revenue represented 17.4% of total revenue in Q3 2019, driven by the DBRS acquisition.
- Segment Margins: DBRS Morningstar adjusted EBIT margin for Q3 2019 was 16% ($6.7 million adjusted EBIT on $41 million revenue). Morningstar's overall adjusted operating margin is typically in the low-20% range.
- Divestiture Gain: The company sold its entire minority stake in United Income, resulting in a $14.4 million benefit (approximately $0.33 EPS).
Material Changes and Performance Drivers
- Organic Growth vs. Expenses: Organic revenue (excluding one-time license fees) grew 10%, while organic Adjusted EBIT (excluding one-time fees and DBRS) declined approximately 4%. This margin compression was driven by increased investments in compensation, production (cloud migration), stock-based compensation (PitchBook incentives), and facilities.
- DBRS Integration: The company experienced modest, temporary revenue dis-synergies in Q3 2019 within U.S. structured finance sub-asset classes due to the alignment of models and methodologies between Morningstar Credit Ratings and DBRS. Management does not expect significant permanent dis-synergies.
- Asset-Based Revenue: Workplace Solutions and Morningstar Investment Management saw low-single-digit year-to-date growth, impacted by fee compression, a mix shift to lower-fee strategies, and lagged effects from the Q4 2018 market downturn.
- Index Growth: Assets linked to Morningstar Indexes reached $64 billion as of September 30, 2019, a 41% year-over-year increase. Strategic beta offerings comprise two-thirds of these assets.
Guidance, Outlook, and Risks
- Guidance: Morningstar does not provide specific revenue or operating margin guidance by product or short-term expense growth forecasts. Management focuses on long-term value creation and capital allocation.
- Outlook: Management expects continued revenue growth in structured finance and corporate ratings as DBRS operations scale in the U.S. and Europe. PitchBook is EBITDA positive and expected to reach the corporate average margin profile over time.
- Capital Allocation: The company aims to balance organic growth, acquisitions, shareholder returns, and debt reduction. Repatriation strategies for overseas cash are being evaluated to accelerate debt paydown.
- Risks: Key risks include the failure of acquisitions to meet expectations, regulatory changes (e.g., Fannie Mae/Freddie Mae privatization), technology outages, and the concentration of data/development work in offshore facilities (China and India).
Investor Verification Checklist
- Verify the timeline for the completion of DBRS model and methodology alignment in the U.S. to assess the duration of revenue dis-synergies.
- Monitor the pace of debt reduction relative to the repatriation of the $254 million (72% of $353M) held in non-U.S. jurisdictions.
- Track the margin expansion trajectory of PitchBook and DBRS Morningstar to confirm they approach the corporate average over time.
- Assess the impact of the new Regulation Best Interest (Reg BI) on Advisor Workstation license renewals and new demand starting June 2020.
- Review future filings for the breakdown of license-based revenue by customer segment (Advisor, Asset Manager, Private Market) as requested by investors.