Business Context and Reporting Period
Company: Morningstar, Inc.
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2007
Business Overview: Morningstar is a leading provider of independent investment research, data, and software for individual investors, financial advisors, and institutional clients. The company operates in three segments: Individual, Advisor, and Institutional. It maintains extensive databases covering mutual funds, stocks, hedge funds, and other investment vehicles globally.
Key Financial Metrics
| Metric | 2007 | 2006 | 2005 |
|---|---|---|---|
| Revenue | $435.1 million | $315.2 million | $227.1 million |
| Operating Income | $117.3 million | $77.5 million | $46.5 million |
| Net Income | $73.9 million | $51.8 million | $31.1 million |
| Diluted EPS | $1.53 | $1.11 | $0.70 |
| Operating Margin | 26.9% | 24.6% | 20.5% |
| Free Cash Flow | $101.0 million | $94.0 million | $41.0 million |
| Cash & Investments | $258.6 million | $163.8 million | $153.2 million |
| Deferred Revenue | $129.3 million | $100.5 million | $71.2 million |
Assets Under Advisement: $97.5 billion (Investment Consulting).
Assets Under Management: $2.2 billion (Morningstar Managed Portfolios).
Material Changes vs. Prior Period
- Revenue Growth: Consolidated revenue increased 38.1% to $435.1 million. Organic revenue growth was 22.8%, while acquisitions contributed approximately 14 percentage points to total growth.
- Segment Performance: The Institutional segment was the primary driver, accounting for 52.9% of revenue and generating approximately 70% of the year-over-year revenue increase. The Advisor and Individual segments grew 22.2% and 20.6%, respectively.
- Profitability: Operating income rose 51.2% to $117.3 million, driven by operating leverage where revenue growth outpaced expense growth. Operating margin expanded by 2.3 percentage points.
- Acquisitions: Significant revenue contribution came from the March 2007 acquisition of the mutual fund data business from Standard & Poor's ($57.8 million cash). The company also completed the acquisition of the remaining 2% of Morningstar Europe NV.
- Expense Increases: Operating expenses rose 33.7%, primarily due to higher compensation costs (including bonuses) and amortization of intangible assets from recent acquisitions.
Guidance, Outlook, Risks, and Unusual Items
Management Commentary & Outlook:
- Strategy: Focus on four growth strategies: enhancing Internet-based platforms (Morningstar.com, Advisor Workstation, Morningstar Direct), becoming a global leader in funds-of-funds management, expanding service range, and growing international presence.
- Capital Expenditures: Management anticipates significantly higher capital spending in 2008 (estimated at $55 million) due to the build-out of a new corporate headquarters in Chicago.
- Guidance Policy: Morningstar does not provide earnings guidance or hold one-on-one meetings with analysts.
Risks & Contingencies:
- Regulatory Investigations: Morningstar Associates, LLC is subject to ongoing investigations by the New York Attorney General's Office and the U.S. Department of Labor regarding investment consulting services for retirement plans. The SEC investigation concluded in January 2007 with no enforcement action. No reserves have been established for the ongoing matters.
- Legal Settlement: In August 2007, the company settled litigation with a former executive in Australia for approximately $3.3 million (AUD $4.0 million), recording $0.9 million as legal expense and adjusting goodwill for the remainder.
- Global Analyst Research Settlement: Revenue from independent equity research provided to six investment banks under this settlement (approx. 5% of consolidated revenue) is at risk of decline after the settlement expires in July 2009.
- Market Risk: Revenue from asset-based fees (16% of total revenue) is sensitive to equity market performance and net inflows/outflows.
Investor Verification Checklist
- Acquisition Integration: Verify the successful integration and revenue contribution of the Standard & Poor's mutual fund data business and the January 2008 Hemscott acquisition.
- Regulatory Outcomes: Monitor the status and potential financial impact of the New York Attorney General and Department of Labor investigations into Morningstar Associates.
- Settlement Expiration: Assess the company's ability to replace revenue from the Global Analyst Research Settlement upon its expiration in July 2009.
- Capital Spending: Track 2008 capital expenditures related to the new Chicago headquarters to ensure they align with the projected $55 million and do not negatively impact free cash flow.
- Asset Flows: Monitor net inflows into the $97.5 billion in assets under advisement, as this directly impacts the high-margin Investment Consulting revenue stream.