Business Context and Reporting Period
Company: Morningstar, Inc.
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2006
Business Overview: Morningstar is a leading provider of independent investment research, data, and asset management services for individual investors, financial advisors, and institutional clients. The company operates in three segments: Individual, Advisor, and Institutional. As of December 31, 2006, Morningstar served over 5.2 million individual investors, 210,000 financial advisors, and 1,700 institutional clients across 15 countries.
Key Financial Metrics
| Metric ($ in thousands) | 2006 | 2005 | 2004 |
|---|---|---|---|
| Revenue | $315,175 | $227,114 | $179,658 |
| Operating Income | $77,527 | $46,480 | $17,735 |
| Net Income | $51,762 | $31,117 | $8,809 |
| Diluted EPS | $1.11 | $0.70 | $0.21 |
| Operating Margin | 24.6% | 20.5% | 9.9% |
| Free Cash Flow | $93,955 | $40,994 | $25,132 |
| Cash & Investments | $163,751 | $153,190 | $95,463 |
| Deferred Revenue | $100,525 | $71,155 | $63,363 |
Material Changes vs. Prior Period
- Revenue Growth: Consolidated revenue increased 38.8% to $315.2 million. Organic revenue growth (excluding acquisitions and currency) was 22.4%. Acquisitions contributed $36.4 million in revenue.
- Profitability: Operating income surged 66.8% to $77.5 million, driven by operating leverage where revenue growth outpaced expense growth. Operating margin expanded 4.1 percentage points to 24.6%.
- Acquisitions: The company completed three major acquisitions in 2006:
- Ibbotson Associates: Acquired for $86.5 million; significantly expanded investment consulting and retirement advice capabilities.
- Aspect Huntley: Acquired for $23.4 million; expanded equity research and publishing presence in Australia.
- InvestorForce Division: Acquired for $10.1 million; added hedge fund and separate account database capabilities.
- Segment Performance:
- Institutional: Revenue grew 52.3% to $146.1 million, becoming the largest segment (46.4% of total revenue). Growth was driven by Investment Consulting and Licensed Data.
- Advisor: Revenue grew 30.3% to $94.7 million, led by Morningstar Advisor Workstation.
- Individual: Revenue grew 27.2% to $80.7 million, driven by Morningstar.com Premium memberships and Equity Research.
- Expense Trends: Operating expenses increased 31.6% to $237.6 million. Increases were primarily due to higher compensation (including bonuses tied to performance) and amortization of intangible assets from acquisitions. Stock-based compensation expense decreased $2.3 million due to the adoption of SFAS 123(R).
Guidance, Outlook, and Risks
- Guidance: Morningstar does not provide earnings guidance or hold one-on-one meetings with analysts. Management focuses on long-term intrinsic value creation.
- Outlook: Management expects continued growth in non-U.S. operations and asset-based fee revenue. The company plans to expand equity research coverage and hedge fund data. A subsequent event noted the agreement to acquire Standard & Poor's mutual fund data business for $55 million (completed March 2007).
- Risks and Contingencies:
- Legal Proceedings: Ongoing litigation in Australia involving former executive Graham Rich seeking damages up to AUD $25 million. A reserve of approximately $2.0 million is recorded. The plaintiff also sought to amend claims to include the Aspect Huntley acquisition.
- Regulatory Investigations: Investigations by the SEC, New York Attorney General, and Department of Labor regarding investment consulting services for retirement plans. The SEC investigation concluded in January 2007 with no enforcement action. The NY AG and DOL investigations remained open as of the filing date.
- Concentration Risk: Revenue from the Global Analyst Research Settlement (equity research for six investment banks) is significant but contracts expire in July 2009. The top five products accounted for 59.5% of consolidated revenue.
- Competition: Intense competition from larger firms (Lipper, S&P, Thomson) with greater resources.
Key Facts for Investor Verification
- Acquisition Integration: Verify the successful integration of Ibbotson Associates and the realization of projected synergies in the Investment Consulting segment.
- Regulatory Resolution: Monitor the status of the New York Attorney General and Department of Labor investigations regarding retirement plan consulting services.
- Equity Research Contract Renewals: Assess the risk associated with the expiration of the Global Analyst Research Settlement contracts in 2009 and the company's ability to retain or replace this revenue stream.
- International Growth: Evaluate the performance of non-U.S. operations, which grew to 14% of total revenue, and the impact of currency fluctuations.
- Deferred Revenue: Note the significant increase in deferred revenue to $100.5 million, indicating strong future revenue visibility but also potential refund liabilities if cancellations occur.