Business Context and Reporting Period
This Form 8-K is a current report filed by Morningstar, Inc. on January 3, 2014, pursuant to Regulation FD. The filing serves to disclose the company's responses to investor questions received through December 27, 2013, covering operational updates, expense management, capital allocation strategies, and specific business segment performance.
Key Financial Metrics and Operational Data
- Free Cash Flow: Approximately $104 million generated through the first three quarters of 2013.
- Capital Deployment (First 9 Months 2013):
- Dividends: $11.7 million
- Stock Buybacks: $63 million
- Acquisitions (net of cash acquired): $11 million
- Total Deployment: Approximately $86 million
- Expense Trends (Q3 2013): Sales and marketing expenses declined 11.5% year-over-year; general and administrative expenses declined 6.5% year-over-year.
- Revenue Growth (Q3 2013): Sales grew 7.8% year-over-year.
- Structured Credit (CMBS) Market Share (2013): Morningstar rated 38 of 109 new-issue deals ($24.5 billion of $82.6 billion total issuance).
Material Changes Versus Prior Period
- Expense Reclassification: Approximately 180 net positions were shifted from sales/marketing and general/administrative categories to cost of revenue due to a reorganization toward a centralized structure. This added an estimated $7 million to cost of revenue while reducing sales/marketing expenses by $4 million and general/administrative expenses by $3 million for the nine months ended September 30, 2013.
- Non-Recurring Costs: General and administrative expenses in the first half of 2012 included $1.6 million for an impairment charge and litigation settlement, which did not recur in 2013, favorably impacting year-over-year comparisons.
- CMBS Performance: In 2013, Morningstar rated 38 deals ($24.5 billion) compared to 19 deals ($15.4 billion) in 2012, reflecting increased market activity and share.
- Surveillance Revenue: Slightly down for the first nine months of 2013 due to sales team changes and increased competition.
Guidance, Outlook, and Management Commentary
- Capital Allocation Priorities: The Board's current priorities are: (1) Reinvestment in the business, (2) Stock repurchases, and (3) Regular dividend growth. Acquisitions are evaluated case-by-case.
- Expense Sustainability: Management attributes lower expense growth to the reorganization, non-recurring prior-year costs, and a higher-than-usual number of open positions. The company is currently hiring to fill these roles.
- Future Product Expansion: Morningstar recently began rating single-family rental securitizations and expects to enter the market for other residential mortgage-backed securities (RMBS) in 2014.
- Risks: Forward-looking statements are subject to risks including global financial uncertainty, market volatility affecting asset-based fees, reputation damage from conflict of interest claims, fiduciary liability, industry consolidation, and potential database outages.
Investor Verification Checklist
- Verify the impact of the reorganization on future cost of revenue versus operating expense trends.
- Monitor the fill rate of open positions to assess if expense growth will accelerate in upcoming quarters.
- Track the success of the new single-family rental and RMBS rating initiatives in 2014.
- Review the 10-K for the year ended December 31, 2012, for a complete description of litigation and risk factors mentioned.
- Confirm the sustainability of the current capital allocation mix (buybacks vs. dividends) as free cash flow evolves.