Business Context and Reporting Period
Company: Morningstar, Inc.
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2008
Business Overview: Morningstar is a leading provider of independent investment research, data, and asset management services to individual investors, financial advisors, and institutional clients globally. The company operates through three primary segments (Individual, Advisor, and Institutional) and maintains operations in 19 countries. In 2008, the company completed six acquisitions, including Hemscott, Tenfore Systems, and Fundamental Data, to expand its global database and international presence.
Key Financial Metrics
| Metric | 2008 | 2007 | Change |
|---|---|---|---|
| Revenue | $502.5 million | $435.1 million | +15.5% |
| Operating Income | $139.1 million | $117.3 million | +18.6% |
| Net Income | $92.5 million | $73.9 million | +25.2% |
| Diluted EPS | $1.88 | $1.53 | +22.9% |
| Operating Margin | 27.7% | 26.9% | +0.8 pp |
| Free Cash Flow | $103.9 million | $101.0 million | +2.9% |
| Cash & Investments | $297.6 million | $258.6 million | +15.1% |
| Deferred Revenue | $130.3 million | $129.3 million | +0.8% |
Note: Free cash flow is defined by the company as cash provided by operating activities less capital expenditures.
Material Changes vs. Prior Period
- Revenue Growth Deceleration: While consolidated revenue grew 15.5%, organic revenue growth slowed significantly to 8.8% compared to 22.8% in 2007. Growth dipped below zero in the fourth quarter due to the global financial crisis.
- Asset-Based Fee Impact: Approximately 13% of revenue is tied to asset-based fees. The severe market downturn (U.S. equity market declined ~37%) caused a sharp drop in assets under advisement (down ~32% to $66.2 billion), negatively impacting the Investment Consulting business.
- Acquisition Activity: The company invested $105.4 million in six acquisitions in 2008, contributing $27.1 million to revenue. Key acquisitions included Hemscott (UK data/media) and Tenfore (global real-time data).
- Expense Management: Operating expenses increased 14.3% to $363.3 million, driven by a 38% increase in headcount (to 2,375 employees) and higher lease costs for a new Chicago headquarters. However, bonus expense declined 4.0% due to lower operating income growth.
- Segment Performance: The Institutional segment generated 55.1% of revenue and was the primary driver of growth, though Investment Consulting revenue was flat due to asset declines. The Individual and Advisor segments grew 10.6% and 10.2%, respectively.
Guidance, Outlook, Risks, and Unusual Items
- Guidance Policy: Morningstar does not provide earnings guidance or hold one-on-one meetings with analysts. Management focuses on long-term intrinsic value rather than short-term forecasts.
- Global Analyst Research Settlement: Revenue from independent equity research provided to six banks under the Global Analyst Research Settlement accounted for ~4% of consolidated revenue. This settlement expires in July 2009, and management expects this revenue stream to decline significantly thereafter.
- Client Retention Risks: Two significant Investment Consulting clients did not renew contracts (one in 2008, one in Q1 2009), representing approximately $17 million in 2008 revenue. Renewal rates for contract-based products declined by ~6 percentage points in 2008.
- Cost Reductions: In response to the economic environment, the company implemented cost reductions effective January 1, 2009, including suspending 401(k) matching contributions, reducing bonus expense, and postponing new hiring.
- Legal Proceedings:
- NewRiver, Inc. Lawsuit: Filed in January 2009 alleging inappropriate access to a database of SEC filings. Outcome is unpredictable.
- Regulatory Investigations: Ongoing investigations by the New York Attorney General and the U.S. Department of Labor regarding Morningstar Associates' retirement plan services. No reserves have been established.
- Market Risk: The company does not hedge currency exposure. Fluctuations in foreign currencies could adversely impact financial results as international revenue grows (24.2% of total in 2008).
Key Facts for Investor Verification
- Revenue Concentration: The top five products (Licensed Data, Investment Consulting, Advisor Workstation, Morningstar.com, Principia) accounted for 58% of consolidated revenue in 2008.
- Settlement Expiration: Verify the company's strategy to replace revenue from the Global Analyst Research Settlement expiring in July 2009.
- Asset Under Advisement Volatility: Monitor the correlation between market performance and the company's asset-based fee revenue, which is highly sensitive to market declines.
- Acquisition Integration: Assess the integration progress and revenue contribution of the six 2008 acquisitions, particularly Hemscott and Tenfore.
- Legal Exposure: Track the status of the NewRiver lawsuit and the NY Attorney General/Department of Labor investigations for potential fines or operational restrictions.
- Organizational Restructuring: Note the shift in 2009 from three audience-based segments (Individual, Advisor, Institutional) to two product-based segments (Investment Information, Investment Management).