Business Context and Reporting Period
Company: Morningstar, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2009
Business Overview: Morningstar provides investment information, software, and research products to individual investors, financial advisors, and institutions, alongside asset management services. In 2009, the company reorganized its reporting into two operating segments: Investment Information (data, software, research) and Investment Management (asset management operations).
Key Financial Metrics
| Metric (in thousands) | Q2 2009 | Q2 2008 | YTD 2009 | YTD 2008 |
|---|---|---|---|---|
| Revenue | $119,533 | $132,237 | $236,265 | $257,681 |
| Operating Income | $32,688 | $41,570 | $67,313 | $76,255 |
| Net Income (Attributable to Morningstar) | $20,544 | $27,999 | $45,506 | $51,075 |
| Diluted EPS | $0.41 | $0.57 | $0.92 | $1.04 |
| Operating Margin | 27.3% | 31.4% | 28.5% | 29.6% |
| Cash from Operations | $39,589 | $47,742 | $31,267 | $49,119 |
| Free Cash Flow | $37,411 | $37,099 | $24,499 | $31,765 |
| Cash & Investments | $323.2 million (as of June 30, 2009) |
Material Changes vs. Prior Period
- Revenue Decline: Consolidated revenue decreased 9.6% in Q2 and 8.3% year-to-date (YTD). The decline was driven primarily by the Investment Management segment, which fell 28.9% due to a 43% drop in assets under advisement (from $99.1B to $56.1B) caused by contract non-renewals and market downturns. The Investment Information segment saw a modest 3.8% decline.
- Expense Management: Operating expenses decreased 4.2% in Q2 and 6.9% YTD. Significant cost reductions were achieved through a revised bonus plan (down $8.6M in Q2), suspension of 401(k) matching, and reduced marketing/travel spend.
- Unusual Items: The company recorded a $3.5 million operating expense in Q2 for estimated penalties related to the timing of tax deposits on stock option exercises. This non-deductible expense increased the effective tax rate by 3.7 percentage points for the quarter.
- Acquisitions: Four acquisitions were completed in Q2 2009 (Global Reports, C.P.M.S., Andex, Intech) for approximately $18.7 million net cash. These contributed roughly 5 percentage points to revenue growth but added to amortization expenses.
- Currency Impact: A stronger U.S. dollar negatively impacted revenue by approximately 4 percentage points due to foreign currency translation.
Guidance, Outlook, and Risks
- Outlook: Management remains cautious regarding the global financial crisis and market volatility. While the U.S. equity market showed strength in Q2, asset management firms continue to scrutinize spending, creating pricing pressure.
- Equity Research Revenue: Revenue from the Global Analyst Research Settlement (GARS) is expected to decline significantly in the second half of 2009 as the settlement period expired in July 2009.
- Amortization: Future amortization expense for intangible assets is estimated at $22.5 million for the full year 2009, driven by recent acquisitions.
- Legal Contingencies:
- IRS Audit: Ongoing audit regarding tax deposit timing; $3.5M penalty recorded.
- NewRiver, Inc. Lawsuit: Allegations of inappropriate database access; outcome unpredictable.
- Regulatory Inquiries: Ongoing cooperation with the SEC, NY Attorney General, and Department of Labor regarding investment consulting services for retirement plans.
- Liquidity: The company maintains a strong liquidity position with $323.2 million in cash and investments, sufficient for foreseeable operating needs without external credit.
Investor Verification Checklist
- Contract Renewals: Verify the status of the two major Investment Consulting contracts lost in late 2008/early 2009 and the impact on future asset-based fee revenue.
- GARS Transition: Assess the company's strategy to replace revenue from the expiring Global Analyst Research Settlement in the second half of 2009.
- Tax Penalty Resolution: Monitor the outcome of the IRS audit regarding stock option tax deposits to determine if the $3.5M charge is final or if further penalties are likely.
- Acquisition Integration: Review the performance of the four Q2 2009 acquisitions (Global Reports, C.P.M.S., Andex, Intech) to ensure they meet revenue and synergy expectations.
- Regulatory Exposure: Track developments in the NewRiver lawsuit and the NY Attorney General/Department of Labor investigations regarding 401(k) advisory services.