Morningstar, Inc. 2011 First-Quarter Form 10-Q Summary
Business Context and Reporting Period
Morningstar, Inc. filed an unaudited Form 10-Q for the quarter ended March 31, 2011. The company provides investment data, software, research, Internet, and asset-management services through two segments: Investment Information and Investment Management. Revenue is primarily recurring through subscriptions, licenses, and asset-based fees.
Financial Performance and Liquidity
| Metric | Q1 2011 | Q1 2010 | Change |
|---|---|---|---|
| Revenue | $151.8 million | $128.3 million | 18.3% |
| Operating income | $31.8 million | $30.9 million | 2.8% |
| Operating margin | 21.0% | 24.1% | (3.1) percentage points |
| Net income attributable to Morningstar | $22.5 million | $20.2 million | 11.6% |
| Diluted EPS | $0.44 | $0.40 | 10.0% |
| Cash flow from operations | $14.3 million | $14.5 million | (0.7)% |
| Capital expenditures | $5.0 million | $1.7 million | 205.3% |
| Free cash flow | $9.3 million | $12.8 million | (27.3)% |
Gross margin was 73.2%, compared with 73.3% in the prior-year quarter. Net income attributable to Morningstar represented approximately 14.9% of revenue, versus approximately 15.7% in Q1 2010. The effective tax rate declined to 31.8% from 35.3%, primarily due to certain deferred tax benefits.
At March 31, 2011, cash and cash equivalents were $193.4 million and investments were $191.9 million, for total cash, cash equivalents, and investments of $385.3 million. Total liabilities were $286.5 million and equity was $823.8 million. The filing does not present borrowings or significant debt; management stated that the company had not needed significant commercial credit or established credit lines.
Segment Results and Material Changes
- Investment Information: Revenue increased 16.3% to $120.4 million, while operating income declined 1.3% to $32.3 million. The operating margin fell to 26.8% from 31.6%, reflecting acquisition-related costs and higher compensation.
- Investment Management: Revenue increased 26.7% to $31.4 million and operating income increased 28.2% to $17.0 million. The operating margin improved to 54.3% from 53.7%. Investment Consulting and Retirement Advice were the primary revenue drivers.
- Organic growth: Excluding $9.0 million of acquisition revenue and a $1.7 million favorable currency impact, revenue increased approximately 10.0%.
- International operations: International revenue increased 22.2% to $43.6 million, representing approximately 29% of consolidated revenue. International organic revenue increased 7.7%.
- Operating expenses: Expenses increased 23.2% to $120.0 million, faster than revenue. Acquisitions, increased headcount, salary increases, incentive compensation, benefits, and commissions were significant contributors.
- Unusual expense: General and administrative expense included $3.2 million related to a separation agreement with former Chief Operating Officer Tao Huang. Q1 2010 included a $0.8 million vacant-office-space charge that did not recur.
- Workforce: Employee count increased to approximately 3,235 from 2,760 a year earlier, including approximately 125 employees added through acquisitions.
Guidance, Outlook, Risks, and Unusual Items
- Management expected 2011 capital expenditures of approximately $14 million to $17 million, primarily for leasehold improvements and office facilities, including the development center in China.
- Based on acquisitions completed through March 31, 2011, expected intangible-asset amortization was approximately $25.7 million for 2011 and $24.3 million for 2012.
- Management anticipated approximately $13.0 million of stock-based compensation expense in 2011, subject to additional grants and changes in forfeiture estimates.
- The board approved a recurring quarterly dividend of $0.05 per share. The Q1 dividend liability was $2.5 million and was paid on April 29, 2011.
- The company had a $100 million share-repurchase authorization through December 31, 2012. As of March 31, 2011, it had repurchased 76,218 shares for $3.8 million and made no repurchases during the quarter.
- Principal risks include economic weakness, competition, market volatility affecting asset-based fees, reputational and fiduciary-liability claims, reliance on offshore development operations, acquisition integration, international operations, and potential outages of database or network facilities.
- Material legal matters included patent litigation by InvestPic, claims involving Egan-Jones and Realpoint, trade-secret litigation involving Business Logic, and a continuing New York Attorney General matter. The company could not predict the outcomes.
- The company was subject to various state, local, and foreign tax audits. The filing states that the potential effect on previously recorded unrecognized tax benefits could not be estimated.
- Morningstar adopted ASU 2009-13 on multiple-deliverable revenue arrangements effective January 1, 2011; management stated that adoption did not significantly affect the timing or amount of revenue recognition.
Important Facts for Investors to Verify
- Whether acquisition-related revenue and expenses continue to support growth without further pressure on operating margins.
- The sustainability of approximately 10% organic revenue growth and the contribution from Morningstar Direct, Advisor Workstation, Investment Consulting, and Retirement Advice.
- The effect of the $3.2 million separation charge, higher bonuses, headcount growth, and ongoing amortization on full-year profitability.
- Whether increased capital expenditures, particularly for the China development center, translate into improved capacity and revenue growth.
- Exposure to market levels and asset flows through asset-based fees, including Investment Consulting, Retirement Advice, and Managed Portfolios.
- Progress and potential financial impact of the disclosed legal proceedings and tax audits.
- Cash deployment among dividends, the authorized share repurchase program, investments, capital expenditures, and potential acquisitions.