Business Context and Reporting Period
Company: Morningstar, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2008
Business Overview: Morningstar provides investment research, data, and software for individual investors, financial advisors, and institutions. Operations are organized into three segments: Individual, Advisor, and Institutional. The reporting period coincided with severe global financial market volatility, including the bankruptcy of Lehman Brothers and government interventions in the financial sector.
Key Financial Metrics
| Metric (in thousands) | Q3 2008 | Q3 2007 | 9 Months 2008 | 9 Months 2007 |
|---|---|---|---|---|
| Revenue | $125,505 | $111,859 | $383,186 | $316,991 |
| Operating Income | $34,176 | $31,445 | $110,431 | $83,918 |
| Net Income | $22,187 | $19,853 | $73,262 | $53,912 |
| Diluted EPS | $0.45 | $0.41 | $1.49 | $1.13 |
| Operating Margin | 27.2% | 28.1% | 28.8% | 26.5% |
| Free Cash Flow | $37,309 | $24,914 | $69,074 | $63,522 |
| Cash & Equivalents | $233,615 | N/A | N/A | N/A |
| Total Assets | $774,750 | N/A | N/A | N/A |
Note: Balance sheet figures are as of September 30, 2008, compared to December 31, 2007 ($159,576 cash; $649,307 total assets).
Material Changes vs. Prior Period
- Revenue Growth: Consolidated revenue increased 12.2% in Q3 and 20.9% year-to-date (YTD). Organic revenue growth was 7.7% in Q3 and 12.6% YTD. Acquisitions (primarily Hemscott) contributed 4.2 percentage points to Q3 growth.
- Segment Performance:
- Institutional: The largest segment (54.9% of revenue), grew 13.3% in Q3 and 27.7% YTD. Growth was driven by Licensed Data and Morningstar Direct, though Investment Consulting slowed due to market declines and a non-renewal of a major client contract.
- Advisor: Revenue grew 10.5% in Q3 and 13.4% YTD, driven by Morningstar Advisor Workstation licenses.
- Individual: Revenue grew 12.4% in Q3 and 14.2% YTD, supported by Morningstar.com Premium memberships and advertising, despite slower subscriber growth due to market conditions.
- Expenses: Operating expenses rose 13.6% in Q3 and 17.0% YTD. Increases were driven by a 34% rise in headcount (to ~2,250 employees), higher sales commissions, and lease costs for a new Chicago headquarters. Bonus expense decreased as a percentage of revenue.
- Acquisitions: Significant activity included the January 2008 acquisition of Hemscott ($51.3M) and September 2008 acquisition of Financial Computer Support, Inc. (FCSI) ($4.9M). A subsequent acquisition of Fundamental Data Limited occurred in October 2008 ($19M).
Outlook, Risks, and Management Commentary
- Market Environment: Management notes the global financial crisis has lengthened sales cycles and increased pressure on renewal pricing. While renewal rates remain strong, new business is facing tighter budgets and more senior management review.
- Investment Consulting: Assets under advisement declined 7% year-over-year to $85.2 billion, impacted by a 20% market decline and net outflows. A specific client non-renewal ($11.3M annual revenue) is expected to impact future results.
- Liquidity: The company maintains a conservative investment policy with a weighted average maturity of one year. Cash and cash equivalents increased to $233.6 million. Management believes current balances are sufficient for foreseeable needs.
- Risks:
- Financial Sector Volatility: Continued market disruption could lead to spending cutbacks by asset management firms and clients.
- Industry Consolidation: Mergers in the financial services sector could result in the loss of clients or reduced revenue.
- Legal Proceedings: Ongoing investigations by the SEC, New York Attorney General, and Department of Labor regarding investment consulting services for retirement plans. No enforcement action or penalties have been imposed to date, but outcomes remain uncertain.
- Guidance: No specific numerical guidance was provided in this filing. Management anticipates stock-based compensation expense of approximately $11.3 million for the full year 2008.
Investor Verification Checklist
- Client Concentration: Verify the impact of the $11.3M Investment Consulting client non-renewal on future revenue streams.
- Acquisition Integration: Monitor the integration and revenue contribution of the Hemscott and FCSI acquisitions against projected synergies.
- Legal Contingencies: Track the status of the SEC, NY Attorney General, and DOL investigations regarding retirement plan consulting services.
- Capital Expenditures: Confirm the timing and total cost of the new Chicago headquarters, with significant payments expected in Q4 2008.
- Market Sensitivity: Assess the correlation between mutual fund asset flows/redemptions and Morningstar's asset-based fee revenue.