Morningstar, Inc. Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2012. The filing also provides unaudited fourth-quarter 2012 information; it is not a quarterly filing. Morningstar operates through Investment Information and Investment Management segments and serves individual investors, advisors, and institutional clients in 27 countries.
Financial performance and liquidity
| Metric | 2012 | 2011 | Change |
|---|---|---|---|
| Revenue | $658.3 million | $631.4 million | 4.3% |
| Operating income | $150.7 million | $138.4 million | 8.9% |
| Operating margin | 22.9% | 21.9% | Up 1.0 percentage point |
| Net income attributable to Morningstar | $108.1 million | $98.4 million | 9.9% |
| Diluted EPS | $2.20 | $1.92 | 14.6% |
| Cash from operations | $146.0 million | $165.0 million | Down 11.5% |
| Free cash flow | $116.0 million | $141.7 million | Down 18.1% |
- Gross margin declined to 70.3% from 71.2%, primarily because cost of goods sold grew faster than revenue.
- Investment Information revenue rose 5.8% to $530.0 million, while segment operating income rose 14.6% to $150.7 million and margin expanded to 28.4%.
- Investment Management revenue declined 1.7% to $128.3 million. Operating income declined 12.2% to $61.1 million and margin fell to 47.6%, primarily because a major client moved fund-of-funds portfolios in-house.
- Cash, cash equivalents, and investments totaled $321.4 million at year-end, down from $470.2 million. Cash and investments were primarily invested in fixed-income securities; approximately 25% of investments were in proprietary Morningstar portfolios.
- The filing does not identify significant traditional corporate debt or material credit facilities. Management stated that it had not needed significant commercial credit or established lines of credit.
- Working capital was $217.2 million, and deferred revenue was $146.0 million, reflecting customer payments collected before services are delivered.
Fourth-quarter 2012
| Metric | Q4 2012 | Q4 2011 |
|---|---|---|
| Revenue | $170.6 million | $158.6 million |
| Operating income | $39.3 million | $34.1 million |
| Net income attributable to Morningstar | $33.0 million | $28.0 million |
| Diluted EPS | $0.69 | $0.55 |
Fourth-quarter 2012 net income included a $5.2 million after-tax gain from the sale of discontinued operations. Excluding that unusual item, reported quarterly earnings growth was materially lower than the headline comparison suggests.
Material changes versus the prior comparable period
- Organic revenue increased 5.2% after excluding divestitures and foreign-currency effects. Foreign currency translation reduced reported revenue by $4.6 million.
- Morningstar Direct was the leading contributor to growth; licensed users increased to 7,435 from 6,144. Morningstar Data and Advisor Workstation also grew.
- Morningstar.com revenue declined because of lower U.S. Premium subscriptions and weaker Internet advertising. U.S. paid Premium subscribers declined to 123,899 from 130,354.
- Investment Management assets under advisement and management ended the year at $149.5 billion versus $180.9 billion, mainly due to the loss of $11.8 billion of a major client’s assets and a $42.9 billion reduction from a change in the scope of services for another client. Excluding those effects, the asset base increased 8.3%.
- Assets under management in managed retirement accounts rose to $25.1 billion from $19.9 billion, and Morningstar Managed Portfolios assets rose to $4.7 billion from $3.1 billion.
- Operating expense increased only 3.0%, helped by $6.4 million lower bonus expense and higher capitalization of software-development costs. Stock-based compensation increased to $18.9 million from $15.3 million.
- Operating cash flow and free cash flow declined because of higher tax payments, bonus payments, accounts receivable, and accrued compensation balances.
- Morningstar repurchased 4.3 million shares for approximately $256.5 million during 2012 and had repurchased 5.1 million shares for $300.9 million cumulatively by year-end. The authorized repurchase program was increased to $500 million.
- The company completed no acquisitions in 2012 and divested two small businesses, receiving approximately $5.7 million. It also acquired minority stakes in HelloWallet and Inquiry Financial Europe.
Outlook, commentary, risks, and unusual items
- Management does not provide public financial forecasts or earnings guidance. It expects 2013 capital expenditures of approximately $33 million to $38 million and intangible-asset amortization of approximately $21.2 million.
- Management expected a recurring quarterly dividend of $0.125 per share in 2013; a $0.125 dividend was declared in February 2013.
- Key risks include financial-market declines affecting asset-based fees, continued shifts from actively managed equity funds to passive and fixed-income products, industry competition, regulatory changes affecting advisory and credit-rating activities, fiduciary liability, cybersecurity and system outages, foreign-currency exposure, and reliance on international development centers.
- Approximately 12% of consolidated revenue came from asset-based fees in 2012, making market performance and client asset levels important to results.
- Pending litigation included claims relating to the Life’s Good S.T.A.B.L. hedge fund rating and a dispute with Business Logic concerning software and trade secrets. The company could not estimate potential losses. A separate Egan-Jones matter was settled in December 2012 on confidential terms.
- The effective tax rate increased to 33.9% from 30.7%, principally because of lower tax credits and incentives and deferred tax benefits recognized in 2011. Gross unrecognized tax benefits were $12.7 million at year-end.
- The filing disclosed a correction to 2011 cash-flow presentation: investment purchases and investment-sale proceeds were each increased by $63.1 million, with no effect on net cash used in investing activities.
- KPMG issued unqualified opinions on the consolidated financial statements and internal control over financial reporting.
Investor verification checklist
- Verify that growth in recurring Investment Information revenue, particularly Morningstar Direct and Morningstar Data, offsets weakness in Morningstar.com and subscription products.
- Assess the sustainability of Investment Management revenue and margins after the major-client portfolio transition and the $42.9 billion scope-related asset reduction.
- Reconcile operating cash flow and free cash flow with earnings, particularly the effects of annual bonus payments, taxes, accounts receivable, and deferred revenue.
- Review the impact of the $500 million repurchase authorization, reduced cash and investments, dividends, and future capital expenditures on capital allocation.
- Monitor pending litigation, unrecognized tax benefits, regulatory developments, fiduciary exposure, and cybersecurity or service interruptions.
- Separate recurring operating earnings from the $5.2 million after-tax gain on discontinued operations and other unusual items, including the $2.0 million loss on the sale of the Bundle investment and accelerated restricted-stock vesting expense.