Morningstar, Inc. 2013 Q2 Form 10-Q Summary
Business context and reporting period
Morningstar filed its unaudited Form 10-Q for the quarter and six months ended June 30, 2013. The company operated through two segments: Investment Information, comprising data, software, research, and credit ratings; and Investment Management, comprising asset management and advisory services. Beginning in the third quarter of 2013, Morningstar planned to report one operating segment while continuing to disclose Information Products and Investment Management revenue.
Financial performance and key metrics
| Metric | Q2 2013 | Q2 2012 | Change | Six months 2013 | Six months 2012 | Change |
|---|---|---|---|---|---|---|
| Revenue | $175.4 million | $166.0 million | 5.7% | $344.3 million | $326.7 million | 5.4% |
| Operating income | $43.6 million | $41.1 million | 6.0% | $84.1 million | $71.5 million | 17.6% |
| Operating margin | 24.8% | 24.8% | Flat | 24.4% | 21.9% | +2.5 pp |
| Net income attributable to Morningstar | $31.1 million | $27.9 million | 11.6% | $60.7 million | $48.0 million | 26.5% |
| Diluted EPS | $0.66 | $0.56 | 17.9% | $1.30 | $0.95 | 36.8% |
| Cash flow from operations | $58.5 million | $49.2 million | 18.9% | $85.1 million | $54.8 million | 55.4% |
| Free cash flow | $48.7 million | $40.2 million | 21.0% | $66.3 million | $36.9 million | 79.7% |
Gross margin improved to 71.3% in the quarter from 70.2%, and to 71.5% for the first half from 69.5%. Operating expenses were 75.2% of quarterly revenue, unchanged year over year, and 75.6% of first-half revenue versus 78.1% in the prior-year period. Development expense increased, while sales and marketing expense declined as a percentage of revenue. Depreciation increased because of higher software-related capital expenditures, while intangible amortization declined as older assets became fully amortized.
Investment Information revenue increased 5.0% in the quarter and 6.1% year to date; its operating margin was 31.7% and 31.1%, respectively. Investment Management revenue increased 8.9% in the quarter and 2.5% year to date; its operating margin was 48.6% and 49.4%, respectively.
Liquidity, cash flow, debt, and capital allocation
- Cash and cash equivalents were $169.8 million at June 30, 2013, compared with $163.9 million at December 31, 2012.
- Investments were $145.0 million, producing total cash, cash equivalents, and investments of $314.8 million, down from $321.4 million at year-end.
- Total liabilities were $321.8 million, including $155.1 million of current deferred revenue. The filing does not disclose significant traditional debt; management stated that it had not needed significant commercial credit or established material credit lines.
- First-half investing cash flow was negative $15.7 million, including $18.9 million of capital expenditures and $11.1 million for the Morningstar Sweden acquisition.
- First-half financing cash flow was negative $58.4 million, including $53.9 million of share repurchases and $5.9 million of dividends.
- The company repurchased 747,769 shares for approximately $51.9 million during the first half. The remaining authorization was approximately $147.1 million at June 30, 2013, under a program expiring December 31, 2014.
Material changes, outlook, and unusual items
- In May 2013, Morningstar acquired the remaining 76% of Morningstar Sweden AB for $14.7 million in cash, increasing ownership to 100%. The transaction generated a preliminary non-cash holding gain of $3.7 million and added preliminary goodwill of $9.9 million and customer-related intangible assets of $9.0 million.
- First-half results benefited from the absence of approximately $1.6 million of prior-year impairment and litigation-settlement expense, as well as lower bonus payments and income tax payments compared with the prior year.
- Management expected approximately $42 million to $47 million of 2013 capital expenditures, approximately $21.2 million of 2013 intangible amortization, and approximately $16.0 million of 2013 stock-based compensation expense. It expected recurring quarterly dividends of $0.125 per share in 2013.
- Management stated that available cash, investments, and operating cash flow should fund operating and cash needs for at least the next 12 months.
- Average assets under advisement and management declined 14.9% year over year to approximately $161.6 billion, although Managed Portfolios and Retirement Solutions grew. Variable-annuity-related revenue remained under pressure, and management expected further pressure from that industry.
- Market volatility, financial-services industry caution, low interest rates, regulation, competition, client consolidation, cybersecurity and network outages, foreign-currency movements, and reliance on asset-based fees were identified as risks.
- Morningstar was defending litigation involving the Life's Good S.T.A.B.L. hedge fund and Business Logic Holding Corporation. For Business Logic, management estimated a possible compensatory loss range of $0 to $5.4 million, excluding potential punitive damages and attorneys' fees; the plaintiff's expert estimated $84 million. No loss estimate was provided for the Life's Good matter.
- Gross unrecognized tax benefits were $14.3 million at June 30, 2013, including $14.0 million of related balance-sheet liabilities. Tax audits were ongoing, and the effect of current audits could not be estimated.
Important facts for investors to verify
- Whether organic revenue growth remains near the reported 6.6% quarterly and 6.3% first-half rates after excluding acquisitions, divestitures, and currency effects.
- The sustainability of margin expansion, particularly given higher salary, bonus, development, depreciation, and corporate expenses.
- The effect of declining average managed and advised assets and variable-annuity exposure on Investment Management revenue.
- The final purchase-price allocation and recurring contribution of Morningstar Sweden, including the preliminary $3.7 million acquisition gain.
- Progress on the $42 million to $47 million capital-expenditure plan and the company's continued share repurchases and dividends.
- Developments in the disclosed litigation, tax audits, unrecognized tax benefits, foreign-currency exposure, and investment portfolio sensitivity to interest rates.