Business Context and Reporting Period
Company: Morningstar, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2009
Business Overview: Morningstar provides investment information, software, and research products to individual investors, financial advisors, and institutions, alongside asset management services. In 2009, the company reorganized its reporting into two operating segments: Investment Information (data, software, research) and Investment Management (asset management operations).
Key Financial Metrics
| Metric (in thousands) | Q1 2009 | Q1 2008 |
|---|---|---|
| Revenue | $116,732 | $125,444 |
| Operating Income | $34,625 | $34,685 |
| Operating Margin | 29.7% | 27.6% |
| Net Income (Attributable to Morningstar) | $24,962 | $23,076 |
| Diluted EPS | $0.51 | $0.47 |
| Cash from Operating Activities | $(8,322) | $1,377 |
| Free Cash Flow | $(12,912) | $(5,334) |
| Cash and Cash Equivalents | $156,712 | $135,937 |
| Total Investments | $129,307 | $123,686 |
Liquidity: As of March 31, 2009, the company held $286.0 million in cash, cash equivalents, and investments. The company maintains a conservative investment policy focused on principal preservation, with no significant commercial credit lines utilized.
Material Changes vs. Prior Period
- Revenue Decline: Consolidated revenue decreased 6.9% year-over-year. The decline was driven primarily by the Investment Management segment, which fell 29.2% due to a 33.9% drop in assets under advisement (from $95.8 billion to $63.3 billion) caused by market losses and the non-renewal of a major client contract. The Investment Information segment remained relatively flat (-0.3%) despite declines in internet advertising and print publications, offset by growth in advisor software and data products.
- Expense Reductions: Operating expenses decreased 9.5% to $82.1 million. This was largely due to a 58.6% reduction in bonus expense ($7.3 million decrease) resulting from revised bonus programs and suspended 401(k) matching contributions. Sales and marketing expenses dropped 21.1% due to reduced advertising and the discontinuation of three print publications.
- Amortization Increase: Depreciation and amortization expenses rose 27.8% to $7.9 million, primarily due to incremental amortization of intangible assets from five acquisitions completed in late 2008.
- Cash Flow Volatility: Operating cash flow turned negative ($8.3 million used) compared to positive cash flow in the prior year. This was primarily due to the timing of annual bonus payments ($58.9 million paid in Q1 2009 vs. $49.3 million in Q1 2008) and the absence of a $3.4 million tenant improvement allowance received in the prior year.
Guidance, Outlook, and Risks
- Outlook: Management remains cautious due to the global financial crisis and market volatility. While the market showed an upturn in March 2009, uncertainty persists regarding asset management fees and advertising spending.
- Global Analyst Research Settlement: Revenue from the Global Analyst Research Settlement (approx. 5% of consolidated revenue) is expected to decline significantly in the second half of 2009 as the settlement period expires in July 2009.
- Acquisitions: The company completed three acquisitions in April and May 2009 (Global Reports LLC, C.P.M.S., and Andex Associates Inc.) for a combined purchase price of approximately $18 million.
- Legal Contingencies:
- NewRiver, Inc. Lawsuit: A lawsuit filed in January 2009 alleging inappropriate access to a database of SEC-filed documents. Outcome is unpredictable.
- Regulatory Investigations: Ongoing cooperation with the SEC, New York Attorney General, and Department of Labor regarding investment consulting services for retirement plans. No enforcement action was taken by the SEC in 2007, but other proceedings remain open.
- Tax Matters: The effective tax rate decreased to 29.9% (from 36.9%) due to the reversal of a $1.4 million reserve for uncertain tax positions and favorable tax benefits from stock option exercises.
Investor Verification Checklist
- Client Concentration Risk: Verify the status of the Investment Consulting client contract expiring May 1, 2009, which represented approximately 8% of the Investment Management segment's revenue.
- Asset Under Advisement (AUA) Trends: Monitor the recovery of AUA levels, which dropped significantly due to market performance and client attrition.
- Revenue Mix Shift: Assess the impact of the expiring Global Analyst Research Settlement on future revenue streams in the Investment Information segment.
- Cash Flow Timing: Understand that Q1 operating cash flow is historically depressed due to annual bonus payouts; compare Q2-Q4 cash flows for a more accurate view of operational liquidity.
- Legal Exposure: Track the resolution of the NewRiver, Inc. lawsuit and ongoing regulatory inquiries regarding retirement plan consulting services.