Business Context and Reporting Period
Company: Morningstar, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2009
Business Overview: Morningstar provides investment information, software, and research products for individual investors, financial advisors, and institutions, alongside asset management services. In 2009, the company reorganized its reporting into two segments: Investment Information and Investment Management.
Key Financial Metrics
| Metric (in thousands) | Q3 2009 | Q3 2008 | YTD 9M 2009 | YTD 9M 2008 |
|---|---|---|---|---|
| Revenue | $120,088 | $125,505 | $356,353 | $383,186 |
| Operating Income | $33,683 | $34,176 | $100,996 | $110,431 |
| Net Income (Attributable to Morningstar) | $22,520 | $22,187 | $68,026 | $73,262 |
| Diluted EPS | $0.45 | $0.45 | $1.37 | $1.49 |
| Operating Margin | 28.0% | 27.2% | 28.3% | 28.8% |
| Free Cash Flow | $32,548 | $37,309 | $57,047 | $69,074 |
| Cash & Investments | $362.2 million (as of Sept 30, 2009) |
Liquidity & Debt: The company maintains a strong liquidity position with $362.2 million in cash, cash equivalents, and investments. Morningstar has no significant commercial credit or debt obligations and relies on operating cash flow and investment proceeds for capital needs.
Material Changes vs. Prior Period
- Revenue Decline: Consolidated revenue decreased 4.3% in Q3 and 7.0% YTD compared to 2008. The decline was driven primarily by the Investment Management segment (down 13.2% in Q3) due to client non-renewals in Investment Consulting and the expiration of the Global Analyst Research Settlement (GARS) in July 2009.
- Cost Reductions: Operating expenses decreased 5.4% in Q3 and 6.4% YTD. Significant savings were achieved through a revised bonus plan (reducing bonus expense by $24.0 million YTD), suspension of 401(k) matching contributions, and reduced travel and marketing spend.
- Acquisitions: The company completed four acquisitions in the first nine months of 2009 (Global Reports, C.P.M.S., Andex Associates, Intech) and increased its stake in Morningstar Korea to 60%, consolidating its results. Acquisitions contributed approximately 5.7 percentage points to YTD revenue growth.
- Unusual Items: A $3.5 million operating expense was recorded in Q2 2009 for estimated penalties related to the timing of tax deposits on stock option exercises. Additionally, a $2.4 million expense was recorded in Q3 to increase lease vacancy reserves for former Ibbotson headquarters.
Guidance, Outlook, and Risks
Management Commentary: Management remains cautious due to the difficult market environment and financial crisis aftermath. While the U.S. equity market showed recovery in Q3, asset management firms continue to scrutinize spending, creating pricing pressure. The company expects capital expenditures of approximately $12 to $13 million for the full year 2009.
Risks and Contingencies:
- Legal Proceedings: A lawsuit filed by NewRiver, Inc. regarding data access was settled in September 2009 with no payments. The company is still subject to an ongoing investigation by the New York Attorney General's Office regarding investment consulting services, with no prediction of outcome.
- Tax Audit: An ongoing IRS audit regarding tax deposit penalties for stock option exercises resulted in the $3.5 million accrual mentioned above.
- Market Risk: Fluctuations in foreign currencies present a risk as international revenue grows; the company does not currently hedge currency risk. Interest rate changes could impact the fair value of the investment portfolio.
Investor Verification Checklist
- Client Retention: Verify the impact of the two major Investment Consulting client non-renewals on future recurring revenue streams.
- GARS Transition: Assess the long-term revenue replacement strategy following the expiration of the Global Analyst Research Settlement, which previously provided significant equity research revenue.
- Tax Penalty Resolution: Monitor the status of the IRS audit regarding stock option tax deposit penalties to determine if the $3.5 million accrual is final or subject to adjustment.
- Acquisition Integration: Review the performance of the four 2009 acquisitions and the consolidated Morningstar Korea subsidiary to ensure they meet projected revenue contributions.
- Organic Growth: Distinguish between revenue growth driven by acquisitions versus organic growth, noting that organic revenue declined 9.4% YTD.