Morningstar, Inc. 2010 Form 10-K Summary
Business context and reporting period
Morningstar provides independent investment data, software, research, ratings, and investment management services through two segments: Investment Information and Investment Management. The filing covers the fiscal year ended December 31, 2010, with quarterly data including the fourth quarter. Morningstar operated in 26 countries and served approximately 7.4 million individual investors, 270,000 financial advisors, and 4,300 institutional clients.
Financial performance and key metrics
| Metric | 2010 | 2009 | Change |
|---|---|---|---|
| Revenue | $555.4 million | $479.0 million | 15.9% |
| Organic revenue | $503.1 million | $479.0 million | 5.0% |
| Operating income | $121.1 million | $124.7 million | (2.9%) |
| Operating margin | 21.8% | 26.0% | (4.2 percentage points) |
| Net income attributable to Morningstar | $86.4 million | $82.1 million | 5.2% |
| Diluted EPS | $1.70 | $1.65 | 3.0% |
| Cash flow from operations | $123.4 million | $101.3 million | 21.9% |
| Free cash flow | $108.6 million | $88.9 million | 22.2% |
Gross profit was $398.3 million, with a 71.7% gross margin versus 73.1% in 2009. The effective tax rate declined to 33.1% from 36.3%. Non-operating income increased to $6.7 million, including a $4.6 million non-cash holding gain related to acquiring the remaining interest in Morningstar Denmark.
Fourth-quarter 2010 revenue was $151.2 million, operating income was $32.3 million, net income attributable to Morningstar was $23.5 million, and diluted EPS was $0.46. Fourth-quarter 2009 revenue was $122.6 million, operating income was $24.3 million, net income attributable to Morningstar was $14.8 million, and diluted EPS was $0.29.
Segments and material changes
- Investment Information: Revenue increased 15.1% to $445.0 million, while operating income declined 7.7% to $127.7 million. The operating margin fell to 28.7% from 35.8%.
- Investment Management: Revenue increased 19.5% to $110.4 million, and operating income increased 7.4% to $56.8 million. The operating margin declined to 51.5% from 57.3%.
- Acquisitions contributed approximately $47.9 million of consolidated revenue and approximately 10 percentage points of reported revenue growth. Morningstar completed seven acquisitions for approximately $102.3 million, including Realpoint, Old Broad Street Research, Aegis Equities Research, Seeds Group, Morningstar Denmark, and an annuity intelligence business.
- Organic revenue growth was driven primarily by Morningstar.com advertising, Morningstar Direct, and Licensed Data. The company lost $12.5 million of 2009 revenue related to the Global Analyst Research Settlement, which ended in July 2009.
- Operating expenses increased 22.6%, faster than revenue, due to acquisitions, higher headcount, restored bonuses and benefits, increased sales commissions, and higher amortization. Bonus expense increased 77.6% to $37.3 million.
- U.S. Morningstar.com Premium subscribers declined to 138,732 from 150,473, while Internet advertising revenue increased 76.2%.
- Total assets under advisement and management increased to $132.9 billion from $82.6 billion, including approximately $39.0 billion associated with a new fund-of-funds program. Investment Consulting assets under advisement were $107.2 billion, managed retirement account assets were $19.6 billion, and Morningstar Managed Portfolios assets were $2.7 billion.
Liquidity, capital resources, debt, and unusual items
- Cash, cash equivalents, and investments totaled $365.4 million at year-end, including $180.2 million of cash and cash equivalents and $185.2 million of investments.
- The filing states that Morningstar had not needed significant commercial credit and had not established significant borrowing facilities. The balance sheet does not present material conventional debt.
- Working capital was $254.6 million, deferred revenue was $146.3 million, total liabilities were $304.9 million, and total equity was $781.4 million.
- Cash used for acquisitions was $102.3 million, while capital expenditures were $14.8 million. The company expected 2011 capital expenditures of approximately $14 million to $17 million.
- Morningstar initiated a quarterly dividend of $0.05 per share and authorized a $100 million share repurchase program. Through December 31, 2010, it had repurchased 76,218 shares for $3.8 million.
- Prior-period financial statements were restated primarily for deferred-tax accounting and vacant-office-space and rent adjustments. The filing states that no prior period was individually materially misstated.
- The company expected approximately $38 million of annual bonus payments in the first quarter of 2011 and approximately $4.2 million of separation payments to two former executives. A January 2011 separation agreement with Tao Huang provided for payments of $3.764 million.
Outlook, management commentary, and risks
Morningstar does not provide public financial forecasts or earnings guidance. Management emphasized long-term organic growth, expansion of its global databases and Internet platforms, development of credit research, fund-of-funds investment management, retirement-income services, and international expansion. Management also stated that it expected to continue selective acquisitions and meaningful investment in product development.
- Key risks include market declines affecting asset-based fees, financial-sector spending, Internet advertising, and assets under advisement and management.
- The company faces fiduciary, regulatory, and litigation exposure from its investment advisory, broker-dealer, and Nationally Recognized Statistical Rating Organization activities.
- Material legal matters include the InvestPic patent lawsuit, Egan-Jones claims involving Realpoint and credit ratings, Business Logic trade-secret litigation, and a continuing New York Attorney General investigation involving Morningstar Associates. The filing states that outcomes cannot be predicted and no reserve was established for the New York matter.
- Other risks include dependence on proprietary data and technology, cybersecurity and privacy exposure, potential network or database outages, foreign-exchange volatility, acquisition integration, competition from larger providers, and concentration of operations in China and India.
- Goodwill was $317.7 million and net intangible assets were $169.0 million at year-end. No goodwill or long-lived-asset impairment was recorded, but future impairment testing depends on estimates of cash flows, growth, and discount rates.
- The company had $153.5 million of non-cancelable operating lease commitments, plus $1.7 million of remaining Shenzhen office build-out payments.
Important facts for investors to verify
- Confirm the effect of the 2010 acquisitions on recurring revenue, margins, cash generation, goodwill, and amortization expense.
- Assess whether organic growth can continue after excluding acquisitions and favorable foreign-currency translation.
- Monitor operating-margin recovery as bonuses, benefits, sales commissions, and acquisition-related costs normalize.
- Evaluate the sustainability and quality of assets under advisement and management, particularly the approximately $39 billion new fund-of-funds program.
- Track Morningstar.com Premium subscriber trends and the durability of the advertising rebound.
- Review the prior-period restatement, deferred-tax balances, $9.1 million of gross unrecognized tax benefits, and ongoing tax audits.
- Monitor the disclosed legal proceedings and regulatory investigation, including potential effects on reputation, expenses, and regulatory permissions.
- Reconcile cash generation with acquisition spending, dividends, share repurchases, bonus payments, and expected 2011 capital expenditures.