Morningstar, Inc. — Form 10-Q Summary
Reporting period: Quarterly and year-to-date periods ended September 30, 2011, compared with the corresponding 2010 periods. Financial statements are unaudited.
Business context and reporting period
Morningstar provides investment data, software, research, internet, communications, and asset-management services. Its two operating segments are Investment Information and Investment Management. Revenue is primarily generated through recurring subscriptions, licenses, and asset-based fees.
Investment Information represented approximately 80% of revenue, while Investment Management represented approximately 20% during the first nine months of 2011. The company had approximately 3,395 employees at September 30, 2011, compared with 3,165 a year earlier.
Key financial metrics
| Metric | Q3 2011 | Q3 2010 | 9M 2011 | 9M 2010 |
|---|---|---|---|---|
| Revenue | $160.1 million | $139.8 million | $472.8 million | $404.2 million |
| Operating income | $33.9 million | $30.2 million | $104.3 million | $88.8 million |
| Operating margin | 21.2% | 21.6% | 22.1% | 22.0% |
| Net income attributable to Morningstar | $21.4 million | $24.7 million | $70.4 million | $62.9 million |
| Diluted EPS | $0.42 | $0.49 | $1.37 | $1.24 |
| Cash provided by operating activities | $45.2 million | $35.3 million | $106.3 million | $80.3 million |
| Free cash flow | $38.9 million | $31.4 million | $91.6 million | $72.6 million |
Gross margin was 70.0% in the third quarter and 71.7% year to date. The effective tax rate was 36.6% in the third quarter and 33.6% year to date.
At September 30, 2011, cash and cash equivalents were $174.3 million and investments were $258.7 million, for combined cash, cash equivalents, and investments of approximately $433.0 million. Total liabilities were $298.1 million and total equity was $836.1 million. The filing does not identify material outstanding borrowings or a significant credit facility; management stated that it had not needed to access significant commercial credit or establish lines of credit.
Material changes versus the prior comparable period
- Third-quarter revenue increased 14.5%; nine-month revenue increased 17.0%. Excluding acquisitions and currency effects, organic revenue increased 11.2% in the quarter and 10.8% year to date.
- Investment Information revenue increased 12.3% in the quarter and 15.3% year to date, but its operating margin declined to 25.0% from 29.3% in the quarter and to 26.9% from 29.6% year to date.
- Investment Management revenue increased 23.4% in the quarter and 23.8% year to date. Operating margin improved to 52.7% from 48.7% in the quarter and to 54.4% from 51.7% year to date.
- Consolidated operating margin declined 0.4 percentage points in the quarter but increased 0.1 percentage point year to date. Higher salaries, bonuses, healthcare costs, and 401(k) matching contributions pressured the quarterly margin.
- Quarterly net income attributable to Morningstar declined 13.4%, primarily reflecting lower non-operating results and a higher tax rate. The prior-year quarter included an approximately $5.1 million holding gain related to the acquisition of additional ownership in Morningstar Denmark.
- Year-to-date operating cash flow increased 32.4% and free cash flow increased 26.2%. Capital expenditures rose 90.7% to $14.7 million, primarily due to capitalized software and technology and facility investments.
- The company repurchased 570,464 shares for approximately $32.1 million during the first nine months and paid $7.5 million of dividends. Total repurchases under the authorized program reached 646,682 shares for approximately $35.9 million.
Guidance, outlook, risks, contingencies, and unusual items
- Management expected 2011 capital expenditures of approximately $18.1 million to $20.1 million and estimated intangible-asset amortization of approximately $26.3 million for 2011 and $23.9 million for 2012.
- Management expected recurring quarterly dividends of $0.05 per share. A $0.05 dividend declared in September 2011 was payable October 31, 2011.
- Management cited volatile markets, weak economic growth, sovereign-debt concerns, financial-services uncertainty, and potential pressure on advertising spending. Market volatility can reduce asset-based fee revenue and affect the pipeline for structured credit ratings.
- Other risks include competition, reputational damage or alleged conflicts of interest, fiduciary-duty liability, reliance on offshore development facilities, product innovation, acquisition integration, non-U.S. operations, cybersecurity or prolonged network/database outages, and foreign-exchange movements. The filing reported no material changes to the risk factors in the 2010 Form 10-K.
- Pending matters include litigation concerning a hedge-fund rating, alleged patent infringement, contractual and rating-business claims, and trade-secret allegations. The company contests the claims but cannot predict their outcomes.
- Gross unrecognized tax benefits were $11.8 million at September 30, 2011; $11.4 million could affect income tax expense if recognized. The company was under examination by U.S. and non-U.S. tax authorities and could not estimate the effect of current audits.
- The first nine months included $3.2 million of expense for a former chief operating officer’s separation agreement and $1.4 million of business tax expense related to prior years. The company completed no acquisitions during the first nine months of 2011.
- Other comprehensive income was adversely affected by a $12.6 million foreign-currency translation loss in the third quarter, reducing comprehensive income attributable to Morningstar to $7.0 million versus $43.5 million in the prior-year quarter.
Most important facts for investors to verify
- Whether Investment Information margin pressure from compensation, benefits, and credit-rating market conditions persists.
- The sustainability of organic revenue growth after adjusting for acquisitions and favorable currency translation.
- The effect of market declines on asset-based fees, assets under advisement, and assets under management.
- Progress on the share-repurchase program, dividend funding, and the planned 2011 capital-expenditure range.
- Potential cash or earnings impacts from pending litigation, tax audits, and unrecognized tax benefits.
- Foreign-exchange exposure and investment-portfolio sensitivity; management estimated that a 100-basis-point interest-rate change would affect investment fair value by approximately $0.9 million.