Business Context and Reporting Period
This Form 8-K, filed on November 4, 2011, by Morningstar, Inc., serves as a Regulation FD disclosure containing responses to investor inquiries regarding the company's performance through the third quarter of 2011. The filing addresses revenue trends, expense management, headcount growth, capital allocation strategies, and the upcoming launch of a new fund rating system.
Key Financial Metrics
- Revenue Growth: Third-quarter revenue increased 14.5% year-over-year (11% organically). Year-to-date (YTD) revenue is up 17.5% versus the prior year.
- Operating Margins: Operating margin was approximately 21% for the third quarter and 22% YTD.
- Revenue per Employee: YTD revenue per employee is $185,700.
- Liquidity and Capital: Net cash position was approximately $8.50 per share at the end of the third quarter. The company maintains a conservative balance sheet with little to no long-term debt.
- Dividends and Buybacks: The annual dividend is $0.20 per share (approx. 12% payout ratio). Under a $100 million repurchase program approved in September 2010, the company has repurchased 636,682 shares for $35.9 million.
- Headcount: Total employee count is just under 3,400, a significant increase from 1,130 in 2005.
Material Changes and Operational Drivers
Sequential sales growth was flat in the third quarter compared to the second quarter, attributed to the non-recurrence of a $2.5 million annual investment conference, a tapering of growth in Internet advertising and Structured Credit Ratings, and market declines affecting Investment Management services. Operating expenses grew slightly faster than revenue in the third quarter, driven by a global compensation review that resulted in $3.2 million in additional salary adjustments, increased headcount, and higher bonus expenses tied to operating income.
Margin compression relative to historical levels (2005-2006) is partly due to the expiration of the Global Analyst Research Settlement, which previously provided a $22 million annual revenue tailwind with minimal expense, and ongoing amortization expenses of approximately $20 million for the first nine months of 2011.
Outlook, Risks, and Management Commentary
Guidance and Strategy: Management does not provide specific forecasts for future top-line growth. The company is reviewing capital allocation options, including potential increases to dividends or share repurchases, given a reduced expectation for near-term acquisitions. The board is actively discussing these alternatives.
Product Launch: Morningstar plans to roll out a new "Morningstar Analyst Rating" for funds in mid-November 2011. This forward-looking, qualitative rating (Gold, Silver, Bronze, Neutral, Negative) will complement the existing quantitative star rating and replace the "Picks and Pans" list.
Risks and Uncertainties: Forward-looking statements are subject to risks including general economic weakness, market volatility affecting asset-based fees, reputation damage from conflict of interest claims, liability for fiduciary duty breaches, concentration of offshore operations in China and India, and potential database outages.
Investor Verification Checklist
- Verify the impact of the new "Morningstar Analyst Rating" on Licensed Data revenue, noting that "Morningstar Essentials" (which includes ratings) comprises about 20% of Licensed Data revenue.
- Monitor the company's capital allocation decisions regarding the $8.50 per share net cash position, specifically any announcements on dividend increases or expanded share repurchases.
- Track operating margin trends to see if expense growth moderates following the one-time compensation adjustments and as new product investments mature.
- Assess the sustainability of headcount growth versus revenue growth, particularly in offshore data centers and sales teams, to evaluate long-term operating leverage.