Morningstar, Inc. Form 10-Q Summary
Reporting period: Quarterly period ended September 30, 2012; filed October 30, 2012. Financial statements are unaudited. Morningstar operates through Investment Information and Investment Management segments, with recurring subscription, license, and asset-based revenue.
Financial Results and Position
| Metric | Q3 2012 | Q3 2011 | 9M 2012 | 9M 2011 |
|---|---|---|---|---|
| Revenue | $161.0 million | $160.1 million | $487.7 million | $472.8 million |
| Operating income | $39.9 million | $33.9 million | $111.4 million | $104.3 million |
| Operating margin | 24.8% | 21.2% | 22.8% | 22.1% |
| Net income attributable to Morningstar | $27.1 million | $21.4 million | $75.1 million | $70.4 million |
| Diluted earnings per share | $0.56 | $0.42 | $1.51 | $1.37 |
| Cash provided by operating activities | $37.5 million | $45.2 million | $92.3 million | $106.3 million |
| Free cash flow | $32.6 million | $38.9 million | $69.4 million | $91.6 million |
- Q3 revenue increased 0.6%; revenue increased 3.1% for the first nine months. Excluding foreign currency effects, organic revenue increased 1.9% in Q3 and 4.2% year to date.
- Net income attributable to Morningstar increased 26.6% in Q3 and 6.7% year to date. The effective tax rate was 35.9% in Q3 and 35.6% year to date, compared with 36.6% and 33.6%, respectively, in the prior-year periods.
- Gross margin was 70.4% in Q3, up from 70.0%, but declined to 69.8% for the first nine months from 71.7%, primarily because salary and production costs increased faster than revenue.
- Cash, cash equivalents, and investments totaled $343.1 million at September 30, 2012, comprising $152.2 million of cash and $190.9 million of investments. Total liabilities were $304.7 million; the filing does not identify significant funded debt or material credit facilities.
- Total assets were $1.06 billion and shareholders’ equity was $755.2 million. Deferred revenue was $164.4 million, up from $155.5 million at December 31, 2011.
Material Changes Versus Prior Comparable Period
- Investment Information revenue rose 2.8% in Q3 and 4.5% year to date; operating income increased 24.0% and 9.7%, respectively. Morningstar Direct, Morningstar Data, and Advisor Workstation led growth.
- Investment Management revenue declined 7.7% in Q3 and 1.9% year to date. Operating income declined 17.8% and 14.9%, respectively, as a large client moved several fund-of-funds portfolios in-house in April 2012.
- Operating expense declined 4.0% in Q3 but increased 2.1% year to date. Lower bonuses and discretionary spending benefited Q3 results; higher salaries, headcount, and production costs increased year-to-date expense.
- Operating cash flow declined 13.2% year to date, primarily due to $42.8 million of bonus payments, lower accrued compensation, and higher income-tax payments. Capital expenditures increased 55.7% to $22.9 million.
- Financing cash outflows increased substantially because Morningstar repurchased 3.17 million shares for approximately $187.0 million in the first nine months, compared with $28.5 million in the prior-year period. Total repurchases under the authorization reached 3.96 million shares costing $231.6 million by September 30.
- Quarterly dividends increased to $0.10 per share from $0.05 per share in the prior-year period. The company paid $14.9 million of dividends in the first nine months.
- The filing corrected 2011 investing cash-flow classifications by increasing both investment purchases and proceeds by $17.2 million; total investing cash flow was unchanged.
Guidance, Outlook, Risks, and Unusual Items
- Management expects 2012 capital expenditures of approximately $28 million to $31 million and intangible amortization of approximately $24.0 million. Stock-based compensation expense is expected to be approximately $15.6 million, subject to future grants and forfeiture estimates.
- Management believes cash balances, investments, and operating cash flow will meet operating and cash needs for at least the next 12 months. The company had not needed significant commercial credit and had not established significant lines of credit.
- Management cited challenging financial-services conditions, industry consolidation, global economic uncertainty, low interest rates, market volatility affecting asset-based fees, and pressure in the variable-annuity industry. Variable annuity-related revenue represented approximately 15% of Investment Management revenue in Q3.
- Other risks include competition and free or low-cost investment information, reputational and fiduciary-liability claims, personal-information security, network or database outages, foreign-currency exposure, and challenges in non-U.S. operations. The company does not hedge currency risk.
- Pending legal matters include claims involving the Life’s Good S.T.A.B.L. hedge fund rating, Egan-Jones Rating, Business Logic, and a New York Attorney General investigation. The company cannot predict the outcomes and has not accrued estimated losses because they cannot reasonably be estimated.
- Unrecognized tax benefits were $11.7 million at September 30, 2012; tax audits are ongoing in U.S. and non-U.S. jurisdictions.
- In October 2012, the company sold Morningstar Investor Relations Services and Morningstar Australasia trade publishing assets. Management expects a fourth-quarter and full-year 2012 gain of approximately $6 million to $7 million.
- No material changes were reported to the risk factors in the 2011 Form 10-K. Management concluded that disclosure controls were effective and that no material changes occurred in internal control over financial reporting.
Most Important Facts to Verify
- Whether Investment Information growth, particularly Morningstar Direct and Morningstar Data, can offset continued weakness in Investment Management, Morningstar.com, and Structured Credit Ratings.
- The sustainability of improved operating margins given higher salaries, headcount, capitalized software costs, and lower bonus expense.
- The effect of the lost Investment Management client, variable-annuity pressure, and market performance on future asset-based fees.
- Cash generation after elevated share repurchases, dividends, bonus payments, and planned capital expenditures.
- The outcome and potential financial or reputational impact of pending litigation, tax audits, and unrecognized tax benefits.
- Whether the expected $6 million to $7 million disposal gain and stated capital-expenditure outlook are realized in subsequent filings.