Business Context and Reporting Period
This Form 8-K is a Current Report filed by Morningstar, Inc. on April 3, 2009. The filing serves as a Regulation FD disclosure, providing answers to investor questions regarding the company's business operations, financial structure, and strategic initiatives. The report incorporates historical financial data for the four quarters of 2008 under the company's new operating segment structure.
Key Financial Metrics
The filing provides a quarterly breakdown of 2008 financial results by segment. Morningstar operates two primary segments: Investment Information and Investment Management. Corporate costs are no longer allocated to segments; instead, depreciation, amortization, and unallocated corporate expenses are reported separately.
| ($ in thousands) | Q1 2008 | Q2 2008 | Q3 2008 | Q4 2008 |
|---|---|---|---|---|
| Revenue | ||||
| Investment Information | $96,506 | $101,580 | $97,075 | $95,532 |
| Investment Management | $28,938 | $30,657 | $28,430 | $23,739 |
| Consolidated Revenue | $125,444 | $132,237 | $125,505 | $119,271 |
| Operating Income | ||||
| Investment Information | $33,288 | $38,697 | $33,595 | $33,322 |
| Investment Management | $15,259 | $17,496 | $16,149 | $11,492 |
| Intangible Amortization & Corp. Depreciation | $(5,070) | $(5,198) | $(5,144) | $(5,138) |
| Corporate Unallocated | $(8,792) | $(9,425) | $(10,424) | $(10,988) |
| Consolidated Operating Income | $34,685 | $41,570 | $34,176 | $28,688 |
| Operating Margin | ||||
| Investment Information | 34.5% | 38.1% | 34.6% | 34.9% |
| Investment Management | 52.7% | 57.1% | 56.8% | 48.4% |
| Consolidated Operating Margin | 27.6% | 31.4% | 27.2% | 24.1% |
Capital Expenditures: The company disclosed expected capital expenditures of approximately $15 million for 2009. Historical capex as a percentage of revenue ranged from 1.5% in 2006 to 9.7% in 2008, with the 2008 spike attributed to the construction of the new Chicago headquarters.
Tax Position: As of December 31, 2008, Morningstar held $44.9 million in Net Operating Loss (NOL) carryforwards related to non-U.S. operations. A valuation allowance has been recorded against all but approximately $3.6 million of these NOLs due to uncertainty regarding their realization.
Material Changes and Segment Performance
- Segment Restructuring: The company adopted a new operating structure in 2008, ceasing the allocation of corporate costs to business segments. This change allows for clearer visibility into segment profitability, with corporate expenses now listed separately.
- Revenue Volatility: Q2 2008 revenue in the Investment Information segment was elevated by approximately $2.3 million due to the annual Morningstar Investment Conference.
- Declining Margins in Q4: Consolidated operating margin declined to 24.1% in Q4 2008 from 31.4% in Q2 2008. The Investment Management segment saw a significant margin compression from 57.1% in Q2 to 48.4% in Q4, likely reflecting the impact of the global financial crisis on asset-based fees.
- Capital Spending: Capital expenditures were significantly higher in 2008 ($48.5 million) compared to prior years, driven by the completion of the new corporate headquarters in Chicago.
Guidance, Outlook, and Risks
Guidance Policy: Morningstar explicitly states it does not provide public financial forecasts. Consequently, the company declined to provide specific long-term targets for gross margin, EBITDA margin, or operating margin, or to confirm if a 3% capex-to-sales ratio is reasonable for future periods.
Outlook and Commentary:
- Operating Leverage: Management believes the business model possesses inherent operating leverage, expecting costs to grow at a slower pace than revenue over the long term, leading to margin improvements.
- Equity Research Distribution: Morningstar joined the Capital Institutional Services (CAPIS) network to expand distribution of its equity research to buy-side investors. While growth is seen in sales to financial advisors and institutions, management does not expect this to replace revenue lost from the expiration of the Global Analyst Research Settlement in July 2009 in the short term.
- Regulatory Impact: New U.S. Labor Department rules regarding retirement plan advice are not expected to have a direct impact on Morningstar, as the rules focus on "conflicted" advisory firms rather than independent firms like Morningstar.
Risks and Contingencies:
- Global Financial Crisis: The filing highlights the ongoing global financial crisis (beginning in 2007) as a primary risk, specifically noting the impact of market volatility on revenue from asset-based fees.
- Tax Uncertainty: There is significant uncertainty regarding the realization of non-U.S. NOL carryforwards, with a valuation allowance recorded against the majority of the $44.9 million balance.
- Operational Risks: Risks include industry consolidation, potential database/network outages, and the availability of free or low-cost investment information.
Key Facts for Investor Verification
- Q4 2008 Performance: Verify the impact of the financial crisis on the Investment Management segment, which saw revenue drop to $23.7 million and operating margin fall to 48.4% in Q4 2008.
- 2009 Capex Expectation: Confirm the $15 million capital expenditure guidance for 2009 against actual spending, noting the significant reduction from the $48.5 million spent in 2008.
- NOL Realization: Monitor the status of the $44.9 million in non-U.S. Net Operating Loss carryforwards, as a valuation allowance is currently held against most of this amount.
- Research Settlement Expiration: Track the revenue impact of the Global Analyst Research Settlement expiration in July 2009 and the effectiveness of the new CAPIS distribution channel in mitigating this loss.
- Segment Reporting: Review future filings to ensure consistency in the new segment reporting structure where corporate costs are unallocated.