Morningstar, Inc. 2010 Q2 Form 10-Q Summary
Business Context and Reporting Period
Morningstar provides investment data, software, research, Internet, print, and asset-management services. Its two operating segments are Investment Information and Investment Management. The filing covers the three and six months ended June 30, 2010, compared with the same periods in 2009. Financial statements are unaudited.
Key Financial Metrics
| Metric | Three Months 2010 | Three Months 2009 | Six Months 2010 | Six Months 2009 |
|---|---|---|---|---|
| Revenue | $136.1 million | $119.5 million | $264.4 million | $236.3 million |
| Operating income | $27.7 million | $32.7 million | $58.6 million | $67.3 million |
| Operating margin | 20.3% | 27.3% | 22.2% | 28.5% |
| Net income attributable to Morningstar | $18.0 million | $20.5 million | $38.2 million | $45.5 million |
| Diluted EPS | $0.36 | $0.41 | $0.76 | $0.92 |
| Cash flow from operations | $30.6 million | $39.6 million | $45.0 million | $31.3 million |
| Free cash flow | $28.4 million | $37.4 million | $41.2 million | $24.5 million |
Six-month revenue increased 11.9%, while operating income declined 12.9% and net income attributable to Morningstar declined 16.1%. The company reported gross margins of 70.8% for the quarter and 72.0% for the first half, down from 74.3% and 74.2%, respectively.
- Investment Information revenue increased 11.5% in the quarter and 9.6% year to date; operating income declined 18.0% and 14.6%, respectively.
- Investment Management revenue increased 24.2% in the quarter and 22.6% year to date; operating income increased 9.6% and 10.9%, respectively.
- International revenue represented 27.3% of second-quarter revenue and increased 22.7% year over year to $37.1 million.
- Cash, cash equivalents, and investments totaled $320.4 million at June 30, 2010, including $154.4 million of cash and cash equivalents and $166.0 million of investments.
- The filing reports no significant commercial debt or credit facilities; management stated that it had not needed to access significant commercial credit.
- Total liabilities were $246.5 million and total equity was $716.1 million at June 30, 2010. Deferred revenue was $140.8 million.
Material Changes Versus the Prior Comparable Period
- Organic revenue, excluding acquisitions and foreign-currency effects, increased 2.7% in the second quarter and 0.5% in the first half. Acquisitions contributed $12.7 million and $22.4 million of revenue, respectively.
- Operating expenses increased 24.8% in the quarter and 21.8% year to date, exceeding revenue growth. Approximately half of the increase was attributable to acquired businesses.
- Bonus expense increased to $9.0 million in the quarter and $16.7 million year to date, reflecting partial reinstatement of compensation and benefits reduced in 2009. Sales commission expense also increased, partly because of a change in the U.S. commission plan.
- The Global Analyst Research Settlement ended in July 2009. Revenue of $5.4 million in the second quarter and $10.9 million in the first half of 2009 associated with the settlement did not recur.
- The $3.5 million non-deductible tax-deposit penalty recorded in the second quarter of 2009 did not recur, benefiting the 2010 quarterly effective tax rate. Conversely, favorable tax reserve reversals recorded in the first half of 2009 did not recur.
- Cash flow from operations increased year to date primarily because first-quarter bonus payments were $21.4 million in 2010 versus $58.9 million in 2009. Second-quarter operating cash flow declined 22.8%.
- The company completed four first-half acquisitions for $67.5 million of cash, including Aegis Equities Research, Old Broad Street Research, Realpoint, and the Footnoted business. Goodwill increased to $281.8 million from $250.0 million at December 31, 2009.
Guidance, Outlook, Risks, and Unusual Items
- Management stated that available cash, investments, and operating cash flow should be sufficient for foreseeable operating and capital needs.
- Expected 2010 capital expenditures were approximately $18 million to $20 million, compared with $12.4 million in 2009. Estimated 2010 intangible-amortization expense was $23.1 million.
- Management identified risks from industry conditions and competition, financial-market volatility affecting asset-based fees, financial-services consolidation, technology or network outages, non-U.S. operations, free or low-cost investment information, reputational claims, and fiduciary-liability exposure.
- The investment portfolio was primarily high-quality fixed-income securities. A 100-basis-point change in interest rates was estimated to affect fair value by approximately $0.7 million. The company did not use currency hedges or derivatives.
- Pending or disclosed legal matters included claims involving Egan-Jones and Realpoint, Aloft Media patent litigation, and Business Logic trade-secret allegations. The filing states that outcomes cannot be predicted. Online News Link litigation was resolved through a confidential license agreement in July 2010.
- Subsequent to quarter end, Morningstar used approximately $22.5 million of cash and investments to acquire the remaining interest in Morningstar Denmark and Seeds Group.
- Management reported effective disclosure controls and no material changes in internal control over financial reporting. No material changes were reported to the risk factors in the 2009 Form 10-K.
Most Important Facts for Investors to Verify
- Whether acquisition-driven growth converts into sustainable organic revenue growth, particularly after the loss of GARS revenue.
- Whether operating margins recover as acquisition costs, bonuses, sales commissions, benefits, and headcount investments are absorbed.
- The contribution and integration progress of Realpoint, OBSR, Aegis, Footnoted, Morningstar Denmark, and Seeds Group.
- The sustainability of cash generation after acquisition spending and expected $18 million to $20 million of 2010 capital expenditures.
- Exposure to market volatility through asset-based fees and the financial condition of investment-management clients.
- Potential financial, operational, or reputational effects of the disclosed litigation and tax audits.
- Changes in Morningstar.com Premium subscriptions, Advisor Workstation licenses, Morningstar Direct licenses, and assets under advisement or management.