Morningstar, Inc. 2013 Q1 SEC Filing Summary
Business context and reporting period
Morningstar, Inc. filed an unaudited Form 10-Q for the quarter ended March 31, 2013. The company provides investment data, software, research, financial communications, and investment management services through two segments: Investment Information and Investment Management. Revenue is primarily generated through subscriptions, license agreements, and asset-based fees.
Financial performance and liquidity
| Metric | Q1 2013 | Q1 2012 | Change |
|---|---|---|---|
| Revenue | $168.9 million | $160.8 million | Up 5.0% |
| Operating income | $40.6 million | $30.4 million | Up 33.4% |
| Operating margin | 24.0% | 18.9% | Up 5.1 percentage points |
| Net income attributable to Morningstar | $29.6 million | $20.1 million | Up 47.1% |
| Diluted earnings per share | $0.63 | $0.40 | Up $0.23 |
| Cash from operating activities | $26.7 million | $5.6 million | Up $21.0 million |
| Free cash flow | $17.6 million | $(3.4) million | Improved by $20.9 million |
- Gross margin increased to 71.6% from 68.7%. Operating expense declined 1.6% to $128.3 million, helped by lower compensation and the absence of approximately $1.6 million of prior-year impairment and litigation settlement expense.
- The effective tax rate decreased to 29.6% from 36.4%, primarily because of adjustments to deferred tax benefits and reduced valuation allowances.
- Cash, cash equivalents, and investments totaled $328.3 million at March 31, 2013, including $224.9 million of cash and cash equivalents and $103.4 million of investments.
- Total liabilities were $306.4 million and total equity was $739.1 million. Management stated that it had not needed significant commercial credit and had not established lines of credit.
- Capital expenditures were $9.1 million. Management expected 2013 capital expenditures of approximately $33 million to $43 million.
Material changes versus the prior comparable period
- Investment Information revenue increased 7.3% to $136.2 million, while segment operating income increased 44.6% to $41.5 million and operating margin expanded to 30.4% from 22.6%.
- Investment Management revenue declined 3.4% to $32.7 million and operating income declined 5.0% to $16.4 million. The primary factor was the loss of approximately $3.2 million of quarterly revenue after a major client brought several fund-of-funds portfolios in-house.
- Organic revenue, excluding acquisitions, divestitures, and foreign currency effects, increased 6.1% to $169.3 million. Currency translation reduced reported revenue by approximately $0.4 million, and 2012 included approximately $1.2 million of revenue from divested businesses that did not recur.
- Morningstar Direct, Morningstar Data, and Structured Credit Ratings led Investment Information growth. Morningstar Direct licenses increased to 7,736 from 6,460 a year earlier, and the company completed 10 new-issue CMBS ratings versus one in the prior-year quarter.
- Investment Management assets under advisement and management decreased to $157.1 billion from $193.1 billion, primarily because of the lost client portfolios and a change in the scope of services for another client. Excluding those portfolios, assets increased 9.8%.
- Other comprehensive income declined to a loss of $8.4 million from income of $7.9 million, mainly because of a $9.1 million unfavorable foreign-currency translation adjustment.
- Investing cash flow changed to a $49.2 million source of cash from a $22.0 million use, primarily because proceeds from investment maturities and sales exceeded purchases.
- The company repurchased 165,541 shares for approximately $10.6 million during the quarter. The remaining authorization under the $500 million repurchase program was approximately $188.5 million at March 31, 2013.
Guidance, outlook, risks, and unusual items
- Management expected recurring quarterly dividends of 12.5 cents per share in 2013. The first-quarter dividend was not paid because the company paid a fifth dividend in December 2012; a 12.5-cent dividend was scheduled for April 30, 2013.
- Management expected approximately $21.0 million of intangible amortization expense in 2013 and approximately $19.8 million in 2014. Expected 2013 stock-based compensation expense was approximately $13.5 million, subject to future grants and forfeiture estimates.
- The company discontinued sales of new Principia subscriptions and began migrating customers to Advisor Workstation and other products. It expected to support Principia customers for approximately two additional years.
- Management continued to expect pressure on revenue from variable-annuity clients and noted challenging financial-services industry conditions, including cautious customer spending, low interest rates, client risk aversion, and increased regulation.
- Key disclosed risks include market volatility affecting asset-based fees, competition and free investment information, financial-services consolidation, data privacy and cybersecurity exposure, network or database outages, non-U.S. operating challenges, reputational and fiduciary-liability claims, and pending litigation.
- Morningstar disclosed litigation involving the Life’s Good S.T.A.B.L. hedge fund rating and Business Logic Holding Corporation. The company is contesting the claims, but stated that outcomes cannot be predicted and that no loss estimate or range could reasonably be made.
- Gross unrecognized tax benefits increased to $13.7 million from $12.7 million. Tax authorities were auditing the company in U.S. and foreign jurisdictions, and the effect of current audits could not be estimated.
- The filing corrected previously reported Q1 2012 investment purchases and proceeds from investment sales by equal and offsetting amounts; total investing cash flow was unchanged.
- A 100-basis-point change in interest rates was estimated to affect the fair value of the investment portfolio by approximately $0.1 million. The company had no currency hedges or derivative instruments and remained exposed to foreign-exchange movements.
Important facts for investors to verify
- Whether Investment Information growth and the 30.4% segment operating margin are sustainable after the favorable comparison with Q1 2012 unusual expenses.
- The effect of the lost Investment Management client, reduced assets under advisement, and continuing variable-annuity pressure on future asset-based fee revenue.
- Actual 2013 capital expenditures versus the $33 million to $43 million expectation and the resulting free cash flow.
- Use of the remaining share-repurchase authorization and the sustainability of the planned quarterly dividend.
- Developments in the Life’s Good S.T.A.B.L. and Business Logic litigation and in the company’s tax audits and unrecognized tax benefits.
- Foreign-currency effects, particularly given the $9.1 million Q1 translation loss and the absence of hedging.