MORNINGSTAR, INC. Item 7.01. Regulation FD Disclosure.
The following information is included in this Current Report on Form 8-K as a
result of
Caution Concerning Forward-Looking Statements
This current report on Form 8-K contains forward-looking statements as that term is used in the Private Securities Litigation Reform Act of 1995. These statements are based on our current expectations about future events or future financial performance. Forward-looking statements by their nature address matters that are, to different degrees, uncertain, and often contain words such as "may," "could," "expect," "intend," "plan," "seek," "anticipate," "believe," "estimate," "predict," "potential," "prospects," or "continue." These statements involve known and unknown risks and uncertainties that may cause the events we discuss not to occur or to differ significantly from what we expect. For us, these risks and uncertainties include, among others,
• failing to maintain and protect our brand, independence, and reputation;
• liability related to cybersecurity and the protection of confidential
information, including personal information about individuals;
• liability for any losses that result from an actual or claimed breach of our
fiduciary duties or failure to comply with applicable securities laws;
• compliance failures, regulatory action, or changes in laws applicable to our
credit ratings operations, or our investment advisory, ESG, and index
businesses;
• failing to respond to technological change, keep pace with new technology
developments, or adopt a successful technology strategy;
• the failure to recruit, develop, and retain qualified employees and
compensation expense associated with these activities in a period of inflation
and rising wage scales in the markets where we operate;
• inadequacy of our operational risk management and business continuity programs
in the event of a material disruptive event, including an outage of our
database, technology-based products and services or network facilities;
• failing to differentiate our products and services and continuously create
innovative, proprietary and insightful financial technology solutions;
• prolonged volatility or downturns affecting the financial sector, global
financial markets, and global economy and its effect on our revenue from
asset-based fees and credit ratings business;
• failing to maintain growth across our businesses in today's fragmented
geopolitical, regulatory and cultural world;
• liability relating to the information and data we collect, store, use, create,
and distribute or the reports that we publish or are produced by our software
products;
• the failure of acquisitions and other investments to be efficiently integrated
and produce the results we anticipate;
• the impact of the current COVID-19 pandemic and government actions in response
thereto on our business, financial condition, and results of operations;
• challenges faced by our non-
data and development work at our offshore facilities in
• our indebtedness could adversely affect our cash flows and financial
flexibility; and
• the failure to protect our intellectual property rights or claims of
intellectual property infringement against us.
Investor Questions and Answers:
We encourage current shareholders, potential shareholders, and other interested
parties to send questions to us in writing and we make written responses
available on a regular basis. The following answers respond to selected
questions received through
If you would like to submit a question, please send an e-mail to investors@morningstar.com or write to us at the following address:
Morningstar, Inc. Investor Relations22 W. Washington St. Chicago, IL 60602 Acquisitions
1) How do you generally think about return on capital when looking at M&A -
specifically with regards to the LCD acquisition can you walk us through how
you thought about the price you paid for the asset, the assumptions you're
making about the business and the cash-on-cash returns you expect from the
investment?
We evaluate the returns of any potential M&A transaction relative to expected returns for other uses of capital. In determining the price we pay for acquisitions, we focus on cash-on-cash returns and internal rates of return. Our acquisition planning is informed by comprehensive diligence and the value we expect to deliver through integrating acquisitions into our business. In the case of Leveraged Commentary & Data (LCD), we believe that low levels of historical investment in the business were not sufficient to realize what we see as its significant growth potential, especially given secular tailwinds for private credit. Based on our work and planning, we are confident in our ability to realize value and excess returns as we invest in the integration.
LCD datasets complement PitchBook's robust product and research capabilities, adding comprehensive coverage of leveraged loans and high-yield debt, and growing coverage of investment-grade bond issuance, distressed debt, corporate bankruptcies, middle market transactions and CLO/fundraising. We believe that this will help drive future PitchBook growth as we are able to provide transparency into the leveraged loan market while creating a centralized tool for private capital and debt markets.
LCD also brings more than 500 leveraged loan indexes in the
Operating Margin
2) Even when you exclude M&A-related earn-out payments, profitability and free
cash flow growth were significantly lower in the quarter and your margins are
at the lowest levels they've been in many years. Can you be more specific
about where you're spending additional dollars across your business?
As we make investments in the business to drive long-term growth, we've focused
on areas where we see the opportunity to build scale and generate attractive
long-term returns. These include investments we've made this year in
Sustainalytics, where we see a strong case to invest in climate and impact
metrics to grow our moat and meet customer needs. At DBRS Morningstar, we're
investing in analytical and operations staff to help maintain our existing
business and continue to grow, especially in
Across the business, the most significant contributor to increased expenses and
lower margins has been compensation and benefit costs, which increased
Excluding stock-based compensation, the other major drivers of operating expense in the second quarter were:
- Professional fees (
independent investigation into certain Morningstar Sustainalytics products, the
use of third-party resources for software development and technology
improvements, and M&A-related expenses.
- Advertising and marketing costs (
issue related to our
advertising and demand generation activities.
- Sales commission costs (
higher amortization of capitalized commissions related to prior-period sales
performance.
- Travel and related expenses (
low levels earlier in the pandemic.
We address the increase in capital expenditures, which contributed to the decline in free cash flow, in a separate question this month.
3) In your 2021 10-K you noted that professional fees increased
prior year, can you provide us with the total dollar amount spent on
professional fees in 2021? What piece of this is recurring?
The total level of professional fees represents a relatively small percentage of
our total expense base. They have grown in recent periods, including for the
2021 fiscal year, due to M&A activity and continued use of third-party resources
to develop software and product capabilities. That is visible in the increase in
our capitalized labor in 2021 which grew
4) Similarly, you note that advertising and marketing costs increased
2021, can you provide the absolute dollar amount spent on advertising and
marketing last year?
If you look at our disclosures, advertising and marketing spend is included as
part of our sales and marketing category on the income statement; we don't
disclose advertising and marketing spend separately. Advertising and marketing
activities include digital campaigns and paid search, sponsorships for events
and conferences, and support of our brand. We are focused on ensuring we have
the right level of spend to drive our lead generation and sales growth and
closely track the return on that investment. As you note, advertising and
marketing costs increased
5) Understand that the mix shift of your revenue is different, but after the
margin erosion that we have seen (profitability back to 2010 levels) what
gives you confidence that profitability will not only recover back to where it
was a few years ago, but also improve over time?
As we've stated previously, we believe that there is inherent leverage in the business and that the investments that we're making will help drive attractive long-term returns and margin improvements. We are focused on growth and scale and shared some of those comparisons at our 2022 annual meeting. We believe significant opportunity exists in key areas including Morningstar Sustainalytics, Wealth, and PitchBook. In certain cases, including the spending we're doing to build climate and impact metrics in the Morningstar Sustainalytics product area and equity data for PitchBook, we expect these returns to materialize more quickly given our ability to get capabilities and products to market quickly and to sell through a subscription model. We're already seeing the fruits of those investments with positive trends in profitability at PitchBook. This contrasts with Wealth Management (direct indexing and open architecture TAMP expansion) where we expect new capabilities to drive flows and AUM growth to help us get to scale, which will take more time to materialize. In both cases, as we look at our long-range forecasts, we're confident that these investments will drive improvements in overall profitability over the long-term.
Compensation
6) (1) Accrued compensation (excl. earnout, including both short-term and
long-term balance sheet items) increased slightly ahead of revenue growth in
2020 and much more dramatically in 2021 (I calculate more than double the pace
of revenue). Could you please specify the drivers behind the trends in Accrued
Compensation as a balance sheet item since 2019 excluding the Sustainalytics
earnout impacts? (2) Operating cash flow declined year over year in 1H 2022,
both on a GAAP basis and excluding the earnout for Sustainalytics in the prior
year comparison. Accrued Compensation and Deferred Sales Commission line item
was a -$102.8 million versus -$28.2 million in 1H'22. Could you please walk
through how much the change in cash bonuses accounted for this YOY change and
what accounts for the remaining impacts to accrued compensation & deferred
sales commission on your cash flow statement? We'd appreciate more details to
help explain operating cash flow dynamics in 1H 2022 vs. 1H 2021 from this
line item.
Excluding the impact of the Sustainalytics earn-out, the biggest drivers of the changes you observe in accrued compensation between 2019 and 2021 were increases in accrued bonus, reflecting strong financial performance and higher headcount, especially in 2021, and higher accrued sales commissions, which tend to track revenue growth. To provide a complete picture of the change in accrued compensation, we've included the impact of the Sustainalytics earn-out in the explanations that follow.
A) Between 2019 and 2020 accrued compensation increased
for the Sustainalytics earn-out accounted for $27.9 million of the increase.
Another $6.5 million was due to an increase in our accrued bonus. Other
drivers included higher accrued commissions, higher accrued sabbatical
expense, higher accrued vacation expense due to lack of paid-time-off (PTO)
usage during a period of COVID-19 restrictions, and higher accrued salary and
payroll liabilities.
B) Between 2020 and 2021, accrued compensation increased
drivers were accrued bonus expense, which increased by $62.4 million due to
strong financial performance relative to targets and higher headcount compared
to the prior year, and $6.2 million related to an increase in the accrual for
the Sustainalytics earnout. Other drivers included higher accrued commissions
and higher accrued sabbatical expense.
The difference between the
7) What is the dollar figure for total company compensation costs in first half
2022 and full-year 2021 (including both stock-based compensation and earn-out
payments)? How much of 2021 compensation is attributable to (cash and total
year-end) bonuses in 2021 (a prior 8K indicated
expense and 10K indicated
correct?) and how does that compare to 2020? What would be a reasonable
estimate of compensation expense split between fixed-in-nature (such as
salaries, payroll, benefits, etc.) vs. variable-in-nature (such as
performance-based bonuses, incentive stock compensation, sales
commissions, etc.)?
In 2021, total compensation and benefits costs represented roughly two-thirds of
our cost structure and included
8) What have been noteworthy changes in incentive compensation structures or
performance-based incentives that we should expect going forward? How large
were annual merit increases relative to prior years? Could you please provide
more details on compensation-related costs from hiring for your largest
product categories cited as investment areas - e.g., PitchBook,
ESG/Sustainalytics, DBRS Morningstar, and Wealth?
The most notable change in the 2022 compensation structure was the increase in
our merit pool with a budgeted global weighted average percentage increase
adjusted for headcount that was roughly double the rate in the prior year; we
believe that the budgeted increase was also almost double the weighted average
market rate across our global footprint as we were focused on retaining talent
in a highly competitive environment. In addition, in 2022, we invested
additional compensation in salaries and bonus levels to close the adjusted
gender pay gap identified in a 2021 review; more detail on this assessment and
the related investment can be found on p. 42 of our Enterprise Sustainability
Report. During the course of the year, we have also invested in geographies and
product areas with higher turnover and/or particularly challenging markets for
talent. That's translated into additional focus on competitive compensation for
existing and new employees in our
As we look ahead, we continue to keep a close eye on the market, our geographies and lines of business, and regularly assess areas in need of review. We are also keeping a careful eye on inflation globally in our approach to 2023.
Debt Agreement
9) What is the current pro forma adjusted EBITDA figure for the trailing twelve
months ended June 30, 2022 , as calculated under your credit agreements? What
is the current (Q2'22) total gross and net consolidated leverage ratios under
this agreement? What is the calculated annualized interest rate on your term
facility ($598 million amount) for the Q2 2022 and what should quarterly
interest costs approximately run for the remainder of 2022 assuming no debt
paydown?
Based on the calculations in our debt agreements, which reflect adjustments
described below, the proforma adjusted EBITDA for the trailing 12-month period
ended
The annualized interest-rate on the
Effect of Changes in Foreign Currency
10) You noted in your 10-Q that in 2Q Morningstar Data revenue rose by 6.6%, or
11.7% organically - can you help us bridge the gap between the reported
number and the organic number? We know that foreign exchange makes up a large
piece of the gap and you talk about the impact from FX to total revenue, but
it would be helpful if you could quantify the specific impact of FX across
your key product areas.
The difference between the increase in reported revenue and organic revenue for Morningstar Data in the second quarter was entirely due to foreign exchange translation. We appreciate the feedback on how we report the impact of foreign currency impact and will take your request under consideration.
Data
11) You provide the number of Morningstar Direct licenses sold every quarter;
would you be able to provide the same level of detail for Morningstar Data?
Are there other KPIs you look at to measure the performance of Morningstar
Data?
We provide Data Product solutions to a wide range of customer types focused on both the manufacturing and distribution of investment products globally. Given the heterogeneity and differences in scale of client use cases, we don't believe that license counts are an appropriate KPI for that business.
The core metrics we track across that customer base include renewal rates, expansion of data sets and licensed use cases to existing customers, and new customer firms licensing Data Product solutions.
Product Pricing
12) Looks like PitchBook contracts may all be priced in USD given that the
business did not see a significant FX impact, is that correct and how are the
rest of the products priced across your license-based segment?
You are correct that PitchBook contracts are priced in USD. Our other licensed-based products are generally priced in the local market currency, with a few exceptions to accommodate client preferences. We are in the process of transitioning the pricing of PitchBook products to local currencies and expect to complete this project by the end of 2023.
Headcount and Talent
13) Starting in the 2H of 2019 you really started to accelerate employee
headcount growth at the company and since that time headcount has grown on
average at 20%+. Can you help us understand how fast you've grown organic
headcount each year? We know a lot of the headcount growth has come from
PitchBook as well as Sustainalytics. Could you provide more detail on the
headcount growth at some of your faster growing products - Sustainalytics,
PitchBook and DBRS Morningstar, in particular on a YOY basis? What is
PitchBook's headcount (excluding LCD) in Q2'22 compared with one year ago?
How fast has sales and marketing headcount grown at the company? How does
that compare to product and software development?
In 2020, headcount grew by 13% excluding the impact of the Sustainalytics acquisition, which closed in July of that year. In 2021, headcount grew 20%; there was no significant impact from acquisitions closed during the year.
As we've discussed, we've focused our investments in headcount in parts of the
business targeted for growth, where we see the opportunity to generate
attractive long-term returns. Between
- Sustainalytics' headcount increased 59% as we hired to support our commercial
growth, scale our operations and further expand research IP, particularly in
the new areas of impact and climate. For more detail, please see the response
to the related question published this month.
- PitchBook's headcount (excluding staff who joined us from LCD and support from
our public equity data team) increased 31% due to growth across the team,
especially in data operations, product management, sales and marketing, and
customer success.
- DBRS Morningstar's headcount increased 22% primarily in the areas of analytical
and operations staff globally.
PitchBook's headcount, excluding LCD and the public equity data group, was
roughly 1,600 as of the end of
In the aggregate, our sales and marketing and product development areas are growing at paces consistent with the level of sales growth. In some areas, product development is growing faster (including in Wealth and Sustainalytics as we are building out new capabilities).
14) How have your priorities for hiring changed over time?
At any given time, our hiring priorities reflect our strategic priorities. In 2022, there has been a greater focus on Wealth, PitchBook, ESG/Morningstar Sustainalytics and DBRS Morningstar as well as on the infrastructure to help us scale.
Those priorities are largely similar to 2021. In many cases, we hire more
heavily in years after acquisitions to drive our investment thesis and returns.
That has been the case with PitchBook, Morningstar Sustainalytics and DBRS
Morningstar. In other cases, like Wealth, our product development activities
have accelerated in the past year given the organic opportunities we see,
particularly in the
Disclosures
15) Why did you stop reporting license counts for Morningstar Direct and
Pitchbook? Will you consider reporting those metrics in the future? You used
to disclose the number of Advisor Workstation Clients as well as the number
of premium subscribers to Morningstar.com in your quarterly KPIs, however it
looks like you removed that disclosure; why did you decide to remove that
information?
We have moved reporting of certain KPIs to the Supplemental Deck which can be found at shareholders.morningstar.com. You can find the license growth rates for Morningstar Direct and PitchBook in those quarterly materials. We will refresh the charts in the next quarterly supplement to include the exact number of licenses for both products. We will also be publishing the data for our premium website subscriptions at the end of each fiscal year in our annual report rather than reporting this metric on a quarterly basis as it does not rank among our top products.
We also made the recent decision to stop disclosing the number of Advisor Workstation clients. We came to the conclusion that it was not as relevant a metric and not highly correlated to revenue given the heterogeneity of our client contracts, and specifically, the wide variation in advisor user counts and size from client to client. As a result, fluctuations in that metric are only indirectly tied to the size of the overall user base and total revenues from the product. For example, two client firms might merge, reducing the total number of clients. However, that merger could have minimal-to-no impact on revenues.
16) Given that you're spending additional dollars to invest at DBRS as well as
PitchBook, why don't you disclose additional details around that spending to
investors?
In the past, we have given directional guidelines on comparative margins within our portfolio. In response to a related question published this month, we have provided more detail on investments we're making in headcount in product areas targeted for growth. We will consider how we can better characterize and explain incremental investments going forward.
Capital Expenditures
17) Could you elaborate on why the Company spends so much on capex? In the last 5
years, the Company spent 20~30% of operating cash flow (OCF) on capex, which
is a pretty large amount compared to other peers, like SPGI. In 2021, SPGI
only spent 1% of OCF on capex whereas MORN spent about 20% of OCF on capex.
In absolute terms, SPGI spent $35 million on capex whereas MORN spent $101.8
million on capex in 2021.
It's difficult for us to assess what drives differences in capex spending relative to our peers. Differences can be driven by nuances in accounting policy related to the treatment of software development costs as well as levels of investment in property, plant and equipment, and technology.
Morningstar's capital expenditures are principally capitalized software development costs, a major ongoing area of investment for the company that represented roughly 72% of total capital expenditures in 2021. Capital expenditures also include leasehold improvements and investments in computer equipment, made in part to accommodate our growing employee base, and investments to support our return-to-office initiative. . . .
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