Business Context and Reporting Period
Company: Morningstar, Inc.
Filing Type: Form 8-K (Current Report)
Date: May 8, 2009
Context: This filing serves as a Regulation FD disclosure containing responses to investor questions regarding the first quarter of 2009. The company operates in the financial information and investment research sector, facing headwinds from the global financial crisis, market volatility, and specific contract expirations.
Key Financial Metrics
The filing provides specific data points regarding expenses, revenue from acquisitions, and assets under advisement, though it does not present a full income statement or balance sheet.
- Revenue from Acquisitions: $5.9 million in Q1 2009 (compared to $27.1 million in 2008).
- Bonus Expense: Declined by $7.3 million in Q1 2009 compared to $12.5 million in Q1 2008. Bonus expense represented approximately 6% of total operating expense in Q1 2009, down from an average of 15% over the prior three years.
- Advertising and Marketing Expense: Declined by $2.3 million in Q1 2009 compared to $5.6 million in Q1 2008.
- Foreign Exchange Impact: Unfavorable impact of $5.7 million on the top line in Q1 2009. Major currency exposures include the Euro, British pound, Australian dollar, and Canadian dollar.
- Assets Under Advisement (Ibbotson Associates): $36.6 billion as of March 31, 2009.
- Assets in Funds-of-Funds Programs: $78.8 billion as of December 31, 2008 (representing a 4.6% market share, down from 5.8% in 2007).
- Effective Tax Rate: 35.9% in 2008 (down from 40.9% in 2007), driven by state tax law changes and incentive stock option benefits.
Material Changes vs. Prior Period
- Revenue Trend: The rate of revenue decline leveled out within Q1 2009 after deteriorating throughout 2008. Some cyclical business lines showed improvement, supported by an end-of-quarter equity market uptick.
- Cost Structure: Significant cost-saving initiatives were implemented, including a reduction in bonus expense and a suspension of 401(k) matching contributions for U.S. employees to avoid job cuts.
- Client Base: Morningstar.com premium subscribers declined by a net 9,000 in Q1 2009 (22,000 cancellations vs. 13,000 new subscribers). The company lost a large Investment Consulting client whose contract expired in early May 2009.
- Product Performance: Principia licenses are declining as advisors cut costs, while Advisor Workstation saw growth driven by a new site license agreement. Morningstar Direct continued to grow globally despite U.S. weakness.
Guidance, Outlook, and Risks
Outlook and Headwinds: Management anticipates continued headwinds from the loss of the Investment Consulting client and the expiration of the Global Analyst Research Settlement in July 2009. While the revenue decline rate has stabilized, the company expects significantly lower equity research revenue following the settlement expiration.
Strategic Initiatives:
- Equity Research Monetization: Plans to expand reach with financial advisors, pursue buy-side sales, and license investment products (e.g., exchange-traded notes) to offset settlement revenue loss.
- Acquisition Strategy: Focus remains on "bolt-on" acquisitions to enhance key market segments, though larger deals are not ruled out.
- Cost Management: The company aims to keep costs in line with revenue, with bonus pools tied to pre-bonus operating earnings performance.
Risks and Contingencies:
- Market Volatility: Revenue from asset-based fees is sensitive to market performance.
- Competition and Pricing: Increased price sensitivity in the investment consulting sector and potential for clients to bring work in-house.
- Legal Liability: The company relies on its balance sheet and Errors & Omissions insurance for potential litigation regarding research and ratings, though it cannot quantify potential liabilities.
- Operational Risks: Risks include database outages, challenges in non-U.S. operations, and the availability of free investment information.
Investor Verification Checklist
- Verify the specific financial impact of the Global Analyst Research Settlement expiration in July 2009 on Q3 and Q4 revenue.
- Confirm the timeline for the resumption of 401(k) matching contributions and its impact on future compensation expenses.
- Monitor the net subscriber count for Morningstar.com to determine if the 9,000 net decline in Q1 stabilizes.
- Assess the success of new monetization strategies for equity research outside of the settlement agreement.
- Review the status of the Investment Consulting pipeline following the loss of the major client in May 2009.