Business Context and Reporting Period
This Form 8-K Current Report was filed by Morningstar, Inc. on January 7, 2011. The filing serves as a Regulation FD disclosure containing responses to investor questions received through January 5, 2011. The company operates as a provider of investment research and data, with principal executive offices in Chicago, Illinois.
Key Financial Metrics and Operational Data
- Revenue Composition (First 9 Months 2010): Approximately 75% contract- or license-based (e.g., Licensed Data, Morningstar Direct); 15% subscription-based (e.g., Morningstar.com, newsletters); remainder from advertising, conferences, and unit-priced products.
- Development Expenses: 9.1% of revenue in Q3 2010, up from 7.9% in Q3 2009.
- Development Headcount: Approximately 740 employees in Q3 2010, up from 540 at the end of 2009. About 75% of new hires were for development centers in China and India.
- Liquidity: Management estimates at least $100 million in "excess" cash, a figure aligned with a recent board authorization for share repurchases.
- Profitability by Region: The U.S. is the most profitable operation, followed by Canada, Asia ex-China, Australia, and Europe. China and India operations are not currently profitable due to large data and development centers.
- Sales Force: Approximately 10 global salespeople dedicated to institutional equity and credit research (up from 4 in 2009).
Material Changes and Trends
- Revenue Mix Shift: The percentage of revenue from contract- and license-based products has steadily increased from approximately 70% five years prior to 75% in the first nine months of 2010.
- Premium Subscription Trends: Since the late 2008 market downturn, the ratio of Premium subscribers to registered users on Morningstar.com has remained below historical levels (historically ~3.4%). This trend persisted through September 2010 despite slight growth in registered users, attributed to economic uncertainty and reduced consumer discretionary spending.
- Advertising Revenue: Strong pricing for Internet advertising sales helped offset lower revenue from Premium memberships through September 2010.
- Investment Consulting Demand: Request for proposal (RFP) activity through September 30, 2010, was substantially higher than in 2009 and aligned with pre-2009 historical levels.
- International Growth: Europe (specifically Switzerland and the U.K.) has been the primary growth driver for Morningstar Direct outside the U.S., followed by growth in Asia, Canada, and Australia.
Guidance, Outlook, and Risks
Guidance and Forecasts: Morningstar explicitly states it does not provide financial forecasts. Consequently, the company declined to comment on expected effective tax rates for 2011 or specific future subscriber ratios.
Strategic Outlook:
- South America: The company is in the beginning stages of building its business in South America, with a specific focus on Brazil (the fifth-largest country by fund assets). Plans include building a fund database, establishing a sales/media presence, and potentially opening local operations. Operations were recently established in Chile and Mexico.
- Product Development: Continued investment in programmers and developers for Morningstar Direct, Advisor Workstation, and Morningstar.com. A new Analyst Research Center module for advisors, including credit research, is expected to be available in Morningstar Advisor Workstation in 2011.
- Credit Research: Corporate credit ratings are being made available to advisors and online brokerages free of charge to drive adoption, with research reports available for a licensing fee.
Risks and Contingencies:
- General industry conditions and global financial uncertainty.
- Impact of market volatility on revenue from asset-based fees.
- Reputation damage from claims regarding conflicts of interest.
- Liability for losses resulting from actual or claimed breaches of fiduciary duties.
- Financial services industry consolidation.
- Prolonged outages of database and network facilities.
- Challenges in non-U.S. operations and the availability of free or low-cost investment information.
Key Facts for Investor Verification
- Verify the sustainability of the 75% contract/license revenue mix and the continued decline in Premium subscriber conversion rates on Morningstar.com.
- Confirm the timeline and capital requirements for the expansion into South American markets, particularly Brazil.
- Monitor the impact of increased development headcount (up ~200 employees year-over-year) on future operating margins.
- Assess the effectiveness of the free credit rating distribution strategy in driving paid licensing of research reports.
- Review the company's strict internal trading policies for equity analysts to ensure continued independence of research.