Business Context and Reporting Period
Company: Morningstar, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2008
Business Overview: Morningstar provides investment research, data, and software products for individual investors, financial advisors, and institutions. The company operates through three segments: Individual, Advisor, and Institutional. The reporting period includes the impact of the January 2008 acquisition of Hemscott data, media, and investor relations businesses.
Key Financial Metrics
| Metric (in thousands) | Three Months Ended June 30, 2008 |
Six Months Ended June 30, 2008 |
|---|---|---|
| Revenue | $132,237 | $257,681 |
| Operating Income | $41,570 | $76,255 |
| Net Income | $27,999 | $51,075 |
| Diluted EPS | $0.57 | $1.04 |
| Operating Margin | 31.4% | 29.6% |
| Cash from Operations | $47,742 | $49,119 |
| Free Cash Flow | $37,099 | $31,765 |
| Cash & Equivalents (Balance) | $206,877 (as of June 30, 2008) | |
| Total Investments (Balance) | $64,560 (as of June 30, 2008) |
Material Changes vs. Prior Period
- Revenue Growth: Consolidated revenue increased 20.6% for the quarter and 25.6% year-to-date compared to 2007. Organic revenue growth (excluding acquisitions and currency) was 13.3% for the quarter and 15.2% year-to-date.
- Profitability: Operating income surged 46.1% for the quarter and 45.3% year-to-date. Operating margins expanded by 5.5 percentage points (quarter) and 4.0 percentage points (year-to-date) due to lower bonus and legal expenses relative to revenue.
- Acquisition Impact: The Hemscott acquisition (completed Jan 2008) contributed 4.4 percentage points to Q2 revenue growth. International revenue grew 41.3% in the quarter, driven by acquisitions and favorable foreign currency translations.
- Segment Performance:
- Institutional: Revenue up 26.6% (Q2) and 36.1% (YTD); largest contributor to growth.
- Advisor: Revenue up 12.1% (Q2) and 14.9% (YTD); driven by Advisor Workstation licenses.
- Individual: Revenue up 16.5% (Q2) and 15.1% (YTD); driven by Morningstar.com Premium and advertising.
- Capital Expenditures: Increased significantly to $17.4 million YTD (vs. $5.9 million in 2007), primarily due to the build-out of the new Chicago headquarters.
Outlook, Risks, and Management Commentary
- Market Environment: Management notes investor uncertainty due to the credit crisis, rising energy prices, and market volatility. While online advertising remains strong, spending cutbacks among asset management firms are a concern.
- Client Concentration Risk: An Investment Consulting client notified the company it will not renew its contract in October 2008. This contract represented approximately $11.3 million (2% of consolidated revenue) for the trailing 12 months.
- Legal Proceedings: The company is cooperating with investigations by the SEC (concluded with no action in Jan 2007), the New York Attorney General's Office, and the U.S. Department of Labor regarding investment consulting services for retirement plans. Outcomes remain unpredictable.
- Future Costs: Amortization of intangible assets from the Hemscott acquisition is expected to be an ongoing cost, estimated at $16.3 million for the remainder of 2008. Total capital expenditures for 2008 are projected at approximately $55 million.
- Tax Rate: The effective tax rate declined to 35.0% (Q2) and 35.9% (YTD) compared to 39.6% in prior-year periods, largely due to tax benefits from incentive stock-option transactions and lower state tax rates.
Investor Verification Checklist
- Client Renewal: Verify the status of the $11.3 million Investment Consulting contract expiring in October 2008 and the company's progress in replacing this revenue.
- Acquisition Integration: Monitor the revenue contribution and expense integration of the Hemscott acquisition, particularly regarding the preliminary purchase price allocations.
- Legal Exposure: Track the resolution of the New York Attorney General and Department of Labor investigations regarding retirement plan consulting services.
- Capital Spending: Confirm the timeline and cash impact of the $55 million projected capital expenditure for the new Chicago headquarters.
- Organic Growth: Assess whether organic revenue growth rates (13-15%) can be sustained given the challenging macroeconomic environment and market volatility.