Morningstar, Inc. Form 10-Q Summary
Business context and reporting period
Morningstar provides investment data, software, research, Internet products, and asset-management services through two operating segments: Investment Information and Investment Management. Revenue is primarily recurring subscription, license, and asset-based-fee revenue. This unaudited Form 10-Q covers the three and six months ended June 30, 2011, compared with the same periods in 2010.
Key financial metrics
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Revenue | $161.0 million | $136.1 million | $312.8 million | $264.4 million |
| Operating income | $38.6 million | $27.7 million | $70.4 million | $58.6 million |
| Operating margin | 24.0% | 20.3% | 22.5% | 22.2% |
| Net income attributable to Morningstar | $26.5 million | $18.0 million | $49.0 million | $38.2 million |
| Diluted EPS | $0.52 | $0.36 | $0.96 | $0.76 |
| Cash flow from operations | $46.8 million | $30.6 million | $61.2 million | $45.0 million |
| Free cash flow | $43.4 million | $28.4 million | $52.7 million | $41.2 million |
Gross margin was 71.9% in the second quarter and 72.6% for the first six months, compared with 70.8% and 72.0%, respectively, in the prior-year periods. The effective tax rate was 32.5% in the quarter and 32.2% year to date, versus 36.2% and 35.7% in 2010.
At June 30, 2011, cash and cash equivalents were $195.0 million and investments were $235.2 million, for total cash, cash equivalents, and investments of approximately $430.2 million. Total liabilities were $296.8 million and equity was $856.2 million. The filing does not disclose material borrowings or a significant credit facility; management stated that the company had not needed significant commercial credit or established lines of credit.
Material changes versus the prior comparable period
- Revenue increased 18.3% in both the quarter and first half. Excluding acquisitions and foreign-currency effects, organic revenue increased 11.2% in the quarter and 10.6% year to date.
- Acquisitions contributed $5.1 million of quarterly revenue and $14.1 million of first-half revenue. No acquisitions were completed in the first six months of 2011.
- Foreign-currency translation contributed approximately 3.4 percentage points to quarterly revenue growth and 2.4 percentage points to first-half growth.
- Investment Information revenue increased 17.5% in the quarter and 16.9% year to date. Investment Management revenue increased 21.5% and 24.0%, respectively.
- Investment Management operating margin improved to 56.2% in the quarter and 55.3% year to date. Investment Information operating margin was 29.0% in the quarter but declined to 27.9% year to date from 29.8%, primarily because of higher compensation-related costs.
- Operating expenses increased 12.9% in the quarter and 17.8% year to date, below revenue growth. Higher salaries, bonuses, benefits, acquisition-related costs, and amortization were major drivers.
- First-half general and administrative expense included $3.2 million related to a separation agreement with the former chief operating officer. The company also recorded $1.4 million of business-tax expense related to prior years in the second quarter.
- Headcount increased to approximately 3,300 from 2,965 a year earlier, with much of the increase related to development centers in China and India.
- Morningstar Direct licenses increased to 5,442 from 4,109 a year earlier. U.S. Advisor Workstation licenses increased to 156,258, while U.S. Morningstar.com Premium subscriptions declined to 136,008 from 143,392.
Guidance, outlook, commentary, risks, and unusual items
- Management expected 2011 capital expenditures of approximately $16 million to $19 million, primarily for office leasehold improvements and computer hardware. First-half capital expenditures were $8.4 million, including substantial spending on the China development center.
- Management expected approximately $25.9 million of intangible-asset amortization in 2011 and $24.4 million in 2012. Estimated future amortization may change with purchase-price allocations, acquisitions, and currency movements.
- Management anticipated approximately $15.4 million of stock-based compensation expense for 2011, subject to additional grants and changes in forfeiture estimates.
- The company hired approximately 30 U.S. employees in July 2011 for its development program, expected to continue hiring in the second half, and expected salary increases in the third quarter.
- Management believed cash, investments, and operating cash flow would be sufficient for foreseeable operating and growth needs. A recurring quarterly dividend of $0.05 per share was declared; $5.0 million of dividends were paid in the first half.
- A $100 million share-repurchase authorization remained available through December 31, 2012. The company had repurchased 78,111 shares for $3.9 million through June 30, 2011.
- Key risks include economic weakness, market volatility affecting asset-based fees, competition, reputational or fiduciary-liability claims, dependence on offshore development facilities, product innovation, acquisition integration, international operations, foreign-currency exposure, and prolonged database or network outages.
- Pending legal matters include patent-infringement litigation by InvestPic, contractual litigation involving Egan-Jones and Morningstar Credit Ratings, and trade-secret litigation involving Business Logic. The company could not predict the outcomes.
- The New York Attorney General matter concerning Morningstar Associates remains unresolved; potential outcomes could include administrative, civil, injunctive, or criminal proceedings, fines, penalties, or other sanctions.
- Gross unrecognized tax benefits increased to $10.9 million from $9.1 million at year-end 2010. The company was under examination by U.S. and foreign tax authorities and could not estimate the effect of current audits.
- Investment-portfolio sensitivity was estimated at approximately $0.7 million for a 100-basis-point change in interest rates. The company did not hedge currency risk with derivatives.
Most important facts to verify
- Whether organic revenue growth and Morningstar Direct license growth continued after the second quarter without comparable acquisition or foreign-currency assistance.
- The sustainability of the improved consolidated margin, particularly given planned hiring, salary increases, bonuses, and higher development spending.
- The effect of declining U.S. Premium Membership subscriptions and weaker investment-website engagement on future Investment Information results.
- Exposure to market declines through asset-based fees and the resulting effect on Investment Management revenue and margins.
- Progress and final cost of the China development center and whether 2011 capital expenditures remain within the $16 million to $19 million expectation.
- Resolution and potential financial impact of the disclosed legal proceedings, New York Attorney General matter, and tax audits.
- Changes in cash, investments, dividends, repurchases, and any future borrowing or credit arrangements.