Business Context and Reporting Period
This Form 8-K, filed on June 9, 2017, by Morningstar, Inc., serves as a Regulation FD disclosure containing responses to investor inquiries regarding the company's first quarter 2017 performance and strategic outlook. The filing addresses the impact of the Department of Labor (DOL) fiduciary rule, the integration of the PitchBook acquisition, and specific operational metrics across licensing, asset-based, and credit rating segments.
Key Financial Metrics and Operational Data
- Assets Under Management (AUM): Total assets under management and advisement grew 11% to $206 billion in Q1 2017.
- Revenue Growth:
- License-based revenue grew 2% in Q1 2017 (excluding $13 million from PitchBook).
- Asset-based revenue grew 7% in Q1 2017 and 4% in full-year 2016.
- Operating Margins: Adjusted operating margins (excluding PitchBook) declined approximately 470 basis points in Q1 2017.
- Headcount: The company added approximately 260 employees organically over the past year, excluding 330 employees acquired via PitchBook.
- Market Share (Credit Ratings): U.S. CMBS new deal market share dropped from 43% in 2015 to 24% in 2016.
Material Changes and Trends
Impact of DOL Fiduciary Rule: In 2016, uncertainty surrounding the DOL rule caused clients to delay spending ("freeze"). In 2017, as compliance approaches clarified, clients returned to business as usual, positively impacting Q1 sales. However, revenue recognition for some Q1 sales is delayed until mid-year implementation.
PitchBook Acquisition: The acquisition is currently margin-dilutive but is expected to reach breakeven in 2017 (excluding intangible amortization and management bonus costs). PitchBook serves approximately 2,200 of an estimated 50,000 potential firms in the private market data space.
Asset-Based Revenue Lag: Asset-based revenue growth has lagged AUM growth due to a strategic shift away from custom asset management toward managed portfolios and retirement offerings. Revenue reporting also lags asset growth due to the use of average assets for revenue calculation versus end-of-period assets for AUM reporting.
Guidance, Outlook, and Risks
Margin Outlook: Management expects operating margins to rebound to historical norms over time. They estimate that 7.5% to 8.5% organic revenue growth is required to achieve these traditional margin levels.
Growth Initiatives: Morningstar has identified five organic growth initiatives, each targeting a $100 million annual revenue run rate by year 10. These initiatives focus on increasing market share and penetration rather than M&A.
Executive Compensation: Starting May 2017, the company introduced Market Stock Units (MSUs) for senior leaders. Vesting is tied to Total Shareholder Return (TSR) over three years, with a target of 10% TSR for 100% vesting.
Risks and Contingencies:
- Liability related to fiduciary duties and data storage.
- Market volatility affecting asset-based fees.
- Technological disruption and the rise of passively managed investment vehicles.
- Concentration of data and development work in offshore facilities (China and India).
Investor Verification Checklist
- Verify the timeline for revenue recognition of Q1 2017 sales delayed due to DOL rule compliance implementation.
- Monitor PitchBook's path to profitability and the specific monetization strategies being deployed.
- Track the shift in asset-based revenue mix from custom asset management to managed portfolios and retirement services.
- Assess the recovery of CMBS issuance volumes and Morningstar's ability to regain market share in credit ratings.
- Confirm the achievement of the 7.5%–8.5% organic revenue growth target required to restore historical operating margins.