Item
7.01. Regulation FD Disclosure.
The
following information is included in this Current Report on Form 8-K as a result of Morningstar, Inc.’s policy regarding public
disclosure of corporate information. Answers to additional inquiries, if any, that comply with this policy are scheduled to become available
around January 20, 2023.
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-U.S. operations, including the concentration of data and development work
at our offshore facilities in China and India; |
| · | 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: December 22, 2022
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 November 30, 2022. We retain
the discretion to combine answers for duplicate or similar questions into one comprehensive response.
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
Relations
22
W. Washington St.
Chicago,
IL 60602
Operating
Margin
| 1) | Based
on the disclosures, the significant YTD operating margin pressure has been primarily driven
by headcount growth, merit-based wage increases, and higher bonus expense. What percentage
of the cost structure is employee-related costs and how much has total compensation per employee
increased in 2022? Can you please break down the drivers of the YTD operating margin
contraction in terms of basis points? |
Employee-related
costs (including compensation and benefits, commissions, and stock-based compensation) accounted for roughly two-thirds of our overall
cost structure in 2021, and, through the first nine months of 2022, that proportion was generally consistent. These costs per employee
fell modestly during the first nine months of 2022 compared to the prior year period, due in part to foreign currency impact. After accounting
for currency and adjustments for M&A-related costs, earnouts, and the reduction and shift of our China operations, employee-related
costs per an average employee count were close to flat. The prior year bonus, resulting from strong performance relative to target in
that period, created favorable variance for the year-to-date, which was offset by increases in other employee-related costs, including
stock-based compensation.
Our operating
margin declined from 14.7% for the first nine months of 2021 to 9.5% for the first nine months of 2022, a decline of 5.2 percentage points.
The drivers of the change in operating margin are presented in the table below:
Percentage
Point Impact on Operating Margin
First Nine
Months of 2022 v. First Nine Months of 2021 (1)
Revenue | |
| 11.6 | % |
Intangible amortization expense, M&A related expenses, and M&A-related earnouts (2) | |
| 1.6 | % |
Severance and personnel expenses and transformation costs
associated with the reduction and shift of our China operations (2) | |
| -2.4 | % |
Compensation and benefits (including severance) (3) | |
| -7.4 | % |
Stock-based compensation | |
| -2.2 | % |
Professional fees | |
| -1.8 | % |
Sales commissions | |
| -1.4 | % |
Travel and related | |
| -1.0 | % |
Advertising and marketing | |
| -0.8 | % |
Infrastructure costs and other (4) | |
| -1.4 | % |
| |
| | |
Total percentage point change in operating margin | |
| -5.2 | % |
| (1) | These
non-GAAP measures may not be comparable to similarly titled measures reported by other companies.
We present adjusted operating margin to show the effect of significant acquisition activity,
better compare period-over-period results, and improve overall understanding of the underlying
performance of the business absent the impact of acquisitions. |
| (2) | These
expenses are added back in our calculation of adjusted operating income and are excluded
from the categories that follow. |
| (3) | Compensation
and benefit costs include salaries, cash bonus, and company-sponsored benefits as well as
severance expenses (excluding those related to the shift of our China operations). |
| (4) | Includes
infrastructure costs such as third-party contracts with data providers, AWS cloud costs to
house data collection and products, and subscriptions to SaaS-based software, as well as
facilities, depreciation, and capitalized labor. |
Headcount
and Talent
| 2) | How
is MORN thinking about headcount growth going forward given the sizeable increase in 2022
with Q3 headcount up 26%? |
As you note,
we’ve made significant investments in headcount through the first three quarters of 2022 to support growth initiatives across the
business. Heading into 2023, we are slowing headcount growth except in our fastest growing product areas. Additionally, we are adding
headcount in Wealth Management to support direct indexing and develop our open architecture TAMP, although at a slowing rate. Finally,
the reduction and shift of our China operations will result in temporary additions to headcount as we hire replacement roles in other
markets and continue to employ certain Shenzhen-based staff through the transition period. That transition is expected to be substantially
complete by the end of the third quarter of 2023.
Morningstar
Employee Turnover
| 3) | Has
the company seen improvement in the 2022 employee turnover rate with the wage increases that
have been implemented? |
As of December
2021, our trailing 12-month average turnover (for permanent, full-time employees) was 18.5%, up from 11.8% in 2020. Through the first
11 months of 2022, the annualized rate is similar to full year turnover for 2021. Encouragingly, we’ve seen voluntary attrition
decline in most markets, with a few exceptions, including our India office, which is experiencing higher turnover than the rest of our
employee population. We’ve also continued to experience relatively high turnover in the Morningstar Sustainalytics product area
given strong demand for ESG expertise. We will report full-year turnover in our 2022 Enterprise Sustainability Report.
Product
Pricing
| 4) | Can
you help us understand the historic approach to the pricing of contracts at different products?
Does the pricing strategy differ by the maturity of the product? How much is dictated by
industry pricing? How much pricing power is there in the different parts of the business? |
Please
discuss the pricing actions that the company has taken in 2022 while the cost base has increased significantly. What level of price
increase has the company taken across its portfolio and how much has pricing been a focus for the company?
We continuously
enhance the value of products and services to meet our clients’ needs, and we generally expect to be compensated for the value
we provide to our clients. Pricing has been a priority focus for us as we enter 2023 given the inflationary environment.
We believe
that we have the most success achieving price increases with our license-based products. Price increases in these product areas are
an important factor in annual and multi-year contracts. We review pricing annually and, like many of our competitors, we focus on
increasing prices where we’ve added the most value; maturity of product does not generally factor into these assessments. We
are generally implementing higher-than-typical annual price increases for 2023 where appropriate, reflecting the increased value
we’re providing as well as increased input costs. Given these factors, we’re instituting price increases ranging from
mid-single-digits for certain products to high-single-digits to low-double-digits for other products.
For DBRS Morningstar,
we look at pricing across the life of a credit transaction including issuer-, transaction- and surveillance-related fees, with price
increases varying by geography and product. We are also raising prices year-over-year in 2023 with the level of the increase depending
on the product type and geography and generally coming in above typical annual increases.
In general,
it’s more difficult to raise prices in the asset-based areas of the business where we’re getting paid in basis points on
assets under management or advisement and where there’s widespread fee compression in the industry. In these areas, we believe
our pricing is competitive and reflective of our value proposition.
Morningstar
Sustainalytics
| 5) | How
much of Morningstar Sustainalytics new client growth in the past 12 months has been with
corporates versus institutional asset managers? Which client base does Morningstar believe
is more important for future growth? |
To give you
a sense of growth trends in those two client segments, it’s helpful to look at trends in net new sales. Net new sales for Sustainalytics’
institutional investor clients (primarily large asset managers and pension funds) increased more than 60% year-to-date through September,
while net new sales to corporates grew about 10% over the same period. Growth in the institutional investor segment was driven by demand
for services that enable clients to successfully meet EU Action Plan requirements, impact solutions that allow clients to measure, manage,
and report on the social and environmental impact of investments, and the expansion of our climate solutions. The lower growth rates
in the corporate segment primarily reflected market conditions. Notably, the slowdown in debt issuance limited the growth of Second Party
Opinions for green bonds, while we’ve seen stronger growth in the licensing of ESG Risk Ratings.
We view the
institutional investor and corporate issuer client segments as equally important for the future growth and success of Sustainalytics
and believe that they are interdependent. Our traditional institutional investor audience remains core to Sustainalytics as demand remains
strong for high-quality ESG data and insights. Meanwhile, our success with institutional investors helps drive increasing demand from
corporate issuers who license their Sustainalytics ESG rating for marketing, capital raising, investor relations, and human capital management
purposes. The credibility provided through a licensed Sustainalytics ESG rating is of high value to both public companies and non-public
companies.
| 6) | Can
you please provide some examples of where Morningstar Sustainalytics is adding unique, proprietary
data to differentiate its offering from peers? |
Morningstar
Sustainalytics offers both proprietary ESG product methodologies and proprietary data sets. The ESG information generally available
in the market is unstructured, incomplete, and sometimes of low quality. We collect ESG information, normalize it, and perform
quality checks and analysis to put it into context. We also combine and perform calculations on ESG data points to create new proprietary
data points and eventually ESG ratings. Examples of our propriety ESG data sets include: company management indicators (evaluations
of company policies, programs and management systems), controversies data (assessments of the degree of involvement in negative events
like oil spills), impact metrics (e.g., gender data), climate performance data (e.g., greenhouse gas emissions and targets), and activity-based
data (which identifies which positive and negative business activities companies are involved in and to what degree). Most of the
data sets cover a 16,000-company universe and in most cases, we deliver both current and historical data to clients.
| 7) | How
much pricing power (if any) does Morningstar Sustainalytics have? Are annual price increases
on average in line with, below, or above that of the rest of the business? |
We believe
we’re delivering value with our proprietary data and analytics and over time are raising prices commensurate with value. We’ve
addressed high-level pricing trends for our license-based products in a response to a different question this month.
DBRS Morningstar
| 8) | How
does the structural trend towards corporates using fewer rating agencies on debt issues affect
DBRS Morningstar? Is this positive or negative for the businesses? |
We’ve
not observed this trend in the corporate markets we’re active in.
To provide
some additional context, our competitive position in the corporate market varies by geography and sector. In Canada, we have a leading
market position with a strong presence in corporate ratings with little client turnover. In the U.S., we are primarily active in the
private/middle market sector and are focused on investment and growth in this area. Insurance companies play a larger role in this market and
are not influenced in their credit rating agency selection by public indexes or legacy investor guidelines. By contrast, the public investment-grade
sector in the U.S. is dominated by Moody’s and S&P, and, given that most non-insurance institutional mandates reference ratings
provided by Moody’s, S&P, and Fitch, and use benchmarks that rely on these ratings, it remains difficult for DBRS Morningstar
to compete. In Europe, the corporate markets are more open, and we have succeeded at establishing a growing position in this sector.
PitchBook
| 9) | You’ve
provided estimates on the total addressable market in dollars for PitchBook. How do you think
about the potential size of PitchBook’s market in terms of total licenses? Is it comparable
to FactSet, for example? Bloomberg? |
We discuss
the methodology behind the total addressable market (TAM) for PitchBook and recent updates to the size of the total TAM in the response
to a related question in July 2022. We build our estimate of the TAM based on the number of firms
that meet our criteria and an estimate of average account revenue rather than building up from total licenses. To be included in the
TAM, a firm must be active in at least one use case that PitchBook supports (three use cases for our companies client segment). Examples
of use cases include identification of comparables and valuation work, deal sourcing, market intelligence, raising capital, etc.
We provided
an estimate of PitchBook’s TAM at our May 2022 Annual Shareholder Meeting. (The presentation is available at shareholders.morningstar.com
under Events and Presentations and the PitchBook discussion starts on page 83.) You can see from
the large TAM ($4.9 billion) and our market share estimate that we have a lot of room for growth.
| 10) | How
important is PitchBook to the future growth of Morningstar? Do you bundle PitchBook with
other products or do you have plans to? |
We view PitchBook
as important to Morningstar’s future growth given the continued convergence of private and public markets, and the increased importance
of private debt, which was a driver of our acquisition of LCD. As a result, we have made significant ongoing investments to support its
growth.
We are starting
to bundle additional capabilities into PitchBook, most notably Morningstar public equity data and ESG ratings, as well as the aforementioned
LCD data. We see significant potential for future product integrations and collaborations across our entire portfolio, including with
the recently announced launch of the Morningstar Unicorn Index, a joint offering built on PitchBook and Morningstar Indexes capabilities.
In addition,
we engage strategically with our large enterprise clients and employ different strategies to bring together solutions across our entire
portfolio of products. Both Morningstar and our clients see attractive opportunities to expand through the bundling of products and associated
pricing strategies.
| 11) | Our
firm is a PitchBook customer and we haven’t received a price increase for two years
while nearly all of our other vendors have implemented meaningful price increases.
Is Morningstar raising the price for PitchBook and what level of price increases are targeted? How
often are PitchBook contracts renewed? |
Most of PitchBook’s
contracts are renewed on an annual basis. We instituted a price increase in July, so clients with contracts that were renewed earlier
in the year will see an increase at their next renewal. We often generate additional growth by expanding licenses with a client and may
not institute a straight price increase if there’s an increase in the total number of licenses. See the response to a related question
for a discussion of how we’ve approached pricing in our license-based businesses.
Morningstar
Founder
| 12) | Does
the Mansueto family have any other indirect or direct holding in Morningstar aside from Joe’s
disclosed stake? |
All of Joe’s
holdings are disclosed annually in Morningstar’s proxy statement and in Schedule 13G filed with the SEC. Both reports include
an explanation of shares that are held by Joe indirectly or where his voting and investment rights are shared.
Capital
Allocation
| 13) | How
has Morningstar historically managed its cash? Has that changed in the current rate environment?
|
We continue
to balance capital allocation priorities, and our approach has not changed. Historically, we have taken a conservative approach to managing
cash and favor short-duration, high-quality, liquid investments. That said, we focus on maximizing yield in that framework through cash
deposits or money market funds. In the current rate environment, we also remain focused on repayment of debt to minimize interest expense.
In addition
to our cash and cash equivalents, we hold investments which include seed capital invested in Morningstar-run investment strategies.
Bonus Plan
| 14) | How
are bonuses budgeted and set? |
Our bonus pool
funding is based on performance relative to financial targets tied to our annual budget. The bonus plan calculation is based on two performance
measures: adjusted revenue and adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization). If adjusted revenue
and adjusted EBITDA are realized at 100% of target, the bonus is funded at 100%. The pool increases or decreases based on performance
against these goals, with a floor at 60% funding and no cap. For more details on the calculations of adjusted revenue and adjusted EBITDA
and the funding formula, please refer to our 2022 proxy statement available at shareholders.morningstar.com.
Every employee
who is not on a commission plan has a bonus target as part of their compensation target, with a payout that varies depending on company
and individual performance. Our bonus pool is derived from the buildup of these individual targets. We record bonus expense quarterly,
based on our realized results and the forecast for the remainder of the year.
Dividend
and Capital Allocation
| 15) | What
is your dividend policy? Do you target a payout ratio? |
Dividends have
consistently been an important part of our capital allocation policy and we are proud to have raised the dividend every year since its
inception. We review our dividend policy and capital allocation regularly with our board. We just announced a 4.2% increase in our quarterly
dividend payable in 2023 and a new $500 million share repurchase program (replacing the existing program from January 2021). While we
don’t have a specific payout target, our average adjusted payout ratio since 2018 is in the mid-20s, with the payout defined as
cash dividends paid divided by adjusted diluted net income. (The latter can be calculated by multiplying adjusted diluted net income
per share by diluted shares outstanding, as reported in our releases.) That has allowed us to support dividend increases while satisfying
other capital allocation objectives including reinvestment in the business, stock repurchases, debt repayment, and mergers and acquisitions.