Morningstar, Inc. Form 10-Q Summary
Business Context and Reporting Period
Morningstar, Inc. filed an unaudited Form 10-Q for the quarter and nine months ended September 30, 2022. The company provides investment data, research, analytics, ratings, software, investment management, workplace solutions, and related services. Revenue is generated primarily from license-based subscriptions, asset-based fees, and transaction-based services.
Morningstar reports one operating segment. The company completed the acquisitions of Leveraged Commentary & Data (LCD) on June 1, 2022 and Praemium Portfolio Services Limited on June 30, 2022.
Financial Performance and Key Metrics
| Metric | Q3 2022 | Q3 2021 | 9M 2022 | 9M 2021 |
|---|---|---|---|---|
| Revenue | $468.2 million | $428.9 million | $1,395.6 million | $1,237.1 million |
| Operating income | $22.0 million | $67.8 million | $132.3 million | $182.2 million |
| Operating margin | 4.7% | 15.8% | 9.5% | 14.7% |
| Net income | $(9.0) million | $49.0 million | $67.2 million | $136.8 million |
| Diluted EPS | $(0.21) | $1.13 | $1.56 | $3.16 |
| Cash flow from operations | $102.1 million | $122.6 million | $194.3 million | $314.0 million |
| Free cash flow | $68.4 million | $92.4 million | $100.9 million | $242.4 million |
Q3 revenue increased 9.2%, while nine-month revenue increased 12.8%. Organic revenue increased 8.5% in Q3 and 14.0% for the first nine months, after excluding acquisitions, accounting changes, and foreign currency effects.
- License-based revenue increased 19.4% in Q3 and 18.3% for the nine-month period, led by PitchBook, Morningstar Sustainalytics, Morningstar Data, and Morningstar Direct.
- Asset-based revenue declined 1.6% in Q3 but increased 4.5% for the nine-month period. Workplace Solutions and Investment Management were pressured by weaker markets and lower assets, partly offset by Morningstar Indexes.
- Transaction-based revenue declined 20.7% in Q3 and 0.9% for the nine-month period, primarily because of reduced global debt issuance affecting DBRS Morningstar.
- Adjusted operating income, excluding intangible amortization, M&A-related costs, and China restructuring-related expenses, was $76.6 million in Q3 and $232.5 million for the first nine months. Adjusted operating margins were 16.4% and 16.7%, respectively.
Liquidity, Cash Flow, Debt, and Capital Allocation
- Cash, cash equivalents, and investments totaled $407.1 million at September 30, 2022, down from $546.1 million at December 31, 2021. Cash and cash equivalents alone were $372.7 million.
- Total debt was $1.16 billion, consisting principally of $809.2 million outstanding under the amended 2022 Credit Agreement and $348.4 million of 2.32% senior notes due 2030.
- The amended credit facilities provided total borrowing capacity of $1.3 billion, including $490.0 million of available revolving capacity at September 30, 2022. The company was in compliance with its debt covenants.
- Operating cash flow and free cash flow declined substantially year over year, affected by lower cash earnings, higher bonus payments, acquisition-related earn-out payments, and weaker asset- and transaction-based businesses.
- Capital expenditures were $93.4 million for the first nine months, up from $71.6 million, reflecting software development, office build-outs, and other technology investments.
- The company repurchased 855,382 shares for $220.2 million during the first nine months and had $178.5 million remaining under its authorization at September 30, 2022. A quarterly dividend of $0.36 per share was approved for payment in October 2022.
Material Changes Versus the Prior Comparable Period
- Operating income declined 67.6% in Q3 and 27.4% for the first nine months; operating margins contracted by 11.1 and 5.2 percentage points, respectively.
- General and administrative expense increased 74.5% in Q3, including $26.3 million of severance expense related to the reduction and relocation of Shenzhen operations.
- Total operating expense increased 23.6% in Q3 and 19.8% for the first nine months, driven by compensation, stock-based compensation, professional fees, sales commissions, travel, and restructuring costs.
- Interest expense increased materially following acquisition-related borrowings, contributing to a Q3 non-operating loss of $24.3 million versus $4.6 million in the prior year.
- Foreign currency translation produced a $51.0 million other comprehensive loss in Q3 and a $105.4 million loss for the first nine months.
- Goodwill increased to $1.54 billion from $1.21 billion at year-end 2021, primarily from the LCD and Praemium acquisitions, partly offset by foreign currency translation.
Guidance, Outlook, Commentary, Risks, and Unusual Items
The filing does not provide specific quantitative revenue, earnings, or margin guidance. Management expects the Shenzhen operational transition to be substantially complete by the end of the third quarter of 2023 and expects lower ongoing run-rate costs after the transition, although temporary duplicate staffing and other transition costs will continue.
- Management expects available cash, investments, operating cash flow, and credit capacity to satisfy operating and cash needs for at least the next 12 months.
- Financial markets, interest-rate volatility, and reduced debt issuance may continue to pressure asset-based fees and DBRS Morningstar revenue.
- Approximately 61% of cash, cash equivalents, and investments was held outside the United States.
- A 100-basis-point increase in SOFR was estimated to increase annual interest expense by approximately $8.1 million based on September 30, 2022 debt balances.
- Key risks include acquisition integration, elevated leverage, cybersecurity and data protection, regulatory scrutiny of ratings and ESG activities, foreign exchange exposure, inflation and labor costs, technology execution, market downturns, and operational concentration in non-U.S. locations.
- The company disclosed ongoing tax audits and data-license audits. Potential losses generally could not be reasonably estimated, but management did not expect these matters to have a material adverse effect.
- The company recorded $26.3 million of Q3 severance expense and reported $27.0 million of severance and personnel expenses plus $3.1 million of transformation costs in its adjusted operating income reconciliation.
Important Facts for Investors to Verify
- Whether strong license-based organic growth, particularly in PitchBook and Sustainalytics, offsets continued weakness in asset-based and transaction-based businesses.
- The pace and cost savings from the Shenzhen workforce transition through its expected completion in Q3 2023.
- LCD and Praemium revenue contributions, integration progress, provisional purchase accounting, and the final LCD contingent consideration payment.
- Debt reduction, interest-rate exposure, covenant compliance, and the availability and use of revolving credit capacity.
- Whether operating margins and free cash flow recover after restructuring, acquisition, compensation, and investment-related costs normalize.
- Changes in assets under management and advisement, market levels, debt issuance volumes, foreign exchange rates, and their effect on future revenue.