Business Context and Reporting Period
Company: Morningstar, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2006
Business Overview: Morningstar provides investment research, data, and software products for individual investors, financial advisors, and institutions. The company operates through three segments: Individual, Advisor, and Institutional. The reporting period includes the impact of three significant acquisitions: Ibbotson Associates (March 2006), Aspect Huntley (July 2006), and the InvestorForce database division (August 2006).
Key Financial Metrics
| Metric (in thousands) | Three Months Ended Sep 30, 2006 | Nine Months Ended Sep 30, 2006 |
|---|---|---|
| Revenue | $81,821 | $228,138 |
| Operating Income | $20,537 | $57,194 |
| Net Income | $13,547 | $38,151 |
| Diluted EPS | $0.29 | $0.82 |
| Operating Margin | 25.1% | 25.1% |
| Free Cash Flow | $28,745 | $66,151 |
| Cash and Investments | $124,250 (as of Sep 30, 2006) | |
| Deferred Revenue | $92,750 (as of Sep 30, 2006) |
Material Changes vs. Prior Period
- Revenue Growth: Revenue increased 43.7% year-over-year (YoY) for the quarter and 37.1% for the nine-month period. Acquisitions contributed $11.6 million to quarterly revenue and $22.8 million to year-to-date revenue.
- Profitability: Operating income surged 66.3% YoY for the quarter and 76.7% for the nine-month period. Operating margins expanded to 25.1% from 21.7% (quarter) and 19.5% (nine months) in the prior year.
- Acquisition Impact: The Institutional segment was the primary growth driver, with revenue up 60.3% for the quarter, largely due to Ibbotson. The Advisor and Individual segments also saw significant growth (31.2% and 31.6% respectively for the quarter).
- Expense Trends: Operating expenses increased 37.5% for the quarter, driven by higher compensation (bonuses and headcount) and amortization of intangible assets from acquisitions. Stock-based compensation expense decreased 29.2% YoY for the nine-month period due to the adoption of SFAS 123(R) and the cessation of liability method accounting post-IPO.
- Cash Flow: Operating cash flow increased 131.0% YoY for the nine-month period to $69.0 million. Investing cash outflows were significant ($112.2 million) due to acquisition costs totaling approximately $116.9 million.
Guidance, Outlook, and Risks
- Outlook: Management expects organic revenue growth to continue, driven by Investment Consulting, Advisor Workstation, and Morningstar.com. The company anticipates capital expenditures of approximately $6.0 million for the full year 2006.
- Accounting Changes: The company adopted SFAS 123(R) effective January 1, 2006, resulting in a cumulative effect of accounting change (net of tax) of $259,000. This change reclassified excess tax benefits from stock option exercises from operating to financing cash flows.
- Legal Contingencies:
- Morningstar Australia: Ongoing litigation with former managing director Graham Rich. Morningstar has a reserve of approximately $1.9 million (AUD $2.5 million) and is vigorously contesting claims seeking up to AUD $25 million.
- Regulatory Investigations: Morningstar Associates is cooperating with investigations by the New York Attorney General, the SEC, and the U.S. Department of Labor regarding investment consulting services for retirement plans. The company cannot predict the outcome or potential financial impact.
- Market Risks: Exposure to foreign currency fluctuations as international revenue grows (currently ~13% of total revenue). No currency hedging is currently in place. Interest rate risk exists regarding the fixed-income investment portfolio.
Investor Verification Checklist
- Acquisition Integration: Verify the realization of synergies and revenue contributions from Ibbotson, Aspect Huntley, and InvestorForce against management projections.
- Amortization Impact: Monitor the ongoing impact of intangible asset amortization ($4.1 million for the nine months) on future operating margins.
- Legal Exposure: Track developments in the Morningstar Australia litigation and regulatory investigations to assess potential liability beyond current reserves.
- Organic Growth: Distinguish between acquisition-driven growth and organic growth (reported as ~23% for the nine months) to assess underlying business health.
- Deferred Revenue: Review the $92.8 million deferred revenue balance as an indicator of future revenue recognition stability.