Morningstar, Inc. Form 10-Q Summary
Reporting period: Three and nine months ended September 30, 2010; filed November 3, 2010. Morningstar operates through Investment Information and Investment Management segments, with predominantly subscription, license, and asset-based recurring revenue.
Financial Performance and Liquidity
| Metric | Q3 2010 | Q3 2009 | 9M 2010 | 9M 2009 |
|---|---|---|---|---|
| Revenue | $139.8 million | $120.1 million | $404.2 million | $356.4 million |
| Operating income | $30.2 million | $33.7 million | $88.8 million | $101.0 million |
| Operating margin | 21.6% | 28.0% | 22.0% | 28.3% |
| Net income attributable to Morningstar | $20.8 million | $22.5 million | $59.0 million | $68.0 million |
| Diluted EPS | $0.41 | $0.45 | $1.16 | $1.37 |
| Cash flow from operations | $35.3 million | $36.1 million | $80.3 million | $67.3 million |
| Free cash flow | $31.4 million | $32.5 million | $72.6 million | $57.0 million |
- Q3 revenue increased 16.4%; nine-month revenue increased 13.4%. Organic revenue, excluding acquisitions and currency effects, increased 6.6% in Q3 and 2.6% year to date.
- Operating expense increased 26.9% in Q3 and 23.5% year to date, exceeding revenue growth. Gross margin declined to 70.9% in Q3 and 71.6% year to date, versus 73.4% and 73.9%, respectively.
- Cash, cash equivalents, and investments totaled $339.3 million at September 30, 2010, including $175.9 million of cash and $163.5 million of investments. Total assets were $1.03 billion.
- The filing does not disclose significant debt or borrowings. Morningstar stated that it had not needed significant commercial credit or established credit lines.
- Current liabilities were $221.8 million, including $135.8 million of deferred revenue. Total liabilities were $270.8 million and total equity was $755.4 million.
Material Changes Versus Prior Period
- Investment Information revenue increased 17.4% in Q3 and 12.2% year to date, while operating income declined 1.5% and 10.5%, respectively. Investment Management revenue increased 12.5% and 18.9%, while operating income declined 6.0% in Q3 and increased 4.7% year to date.
- Revenue benefited from Licensed Data, Morningstar Direct, Internet advertising, advisor software, investment research, and Investment Management products. The company lost $1.5 million of Q3 and $12.5 million of nine-month 2009 revenue related to the Global Analyst Research Settlement, which ended in July 2009.
- Costs increased due to acquisitions, higher salaries, bonuses, sales commissions, employee benefits, and amortization. Bonus expense rose 69.9% in Q3 and 83.2% year to date.
- Depreciation and amortization increased 49.3% in Q3 and 20.3% year to date, primarily because of acquisition-related intangible amortization and a favorable amortization adjustment recorded in Q3 2009.
- Year-to-date operating cash flow benefited from substantially lower bonus payments: $21.4 million in 2010 versus $58.9 million in 2009.
- Six acquisitions were completed in the first nine months, including Aegis Equities Research, Old Broad Street Research, Realpoint, Seeds Group, and the remaining ownership interest in Morningstar Denmark. Acquisition-related cash payments totaled $88.7 million, and goodwill increased from $250.0 million at year-end 2009 to $311.2 million.
Outlook, Unusual Items, and Risks
- Management stated that cash balances, investments, and operating cash flow should be sufficient for foreseeable operating and growth needs.
- Expected 2010 capital expenditures were approximately $18 million to $20 million, compared with $12.4 million in 2009. Estimated intangible amortization expense was approximately $24 million in 2010 and 2011. Estimated 2010 stock-based compensation expense was approximately $14.1 million.
- The company approved a recurring quarterly dividend of $0.05 per share and a share repurchase authorization of up to $100 million. No shares had been repurchased under the program as of September 30, 2010.
- Q3 non-operating income included a preliminary $5.1 million holding gain from acquiring the remaining interest in Morningstar Denmark. The effective tax rate increased to 43.2% from 35.5%, partly due to $5.8 million of non-cash tax expense related to the Denmark gain and prior-period taxes on equity-method earnings.
- Morningstar paid $4.9 million in the first nine months to executives related to the tax treatment of certain stock options; the filing states that a future cash tax benefit is expected to partially offset the payment.
- Material contingencies included litigation involving Realpoint and Egan-Jones, a trade-secret dispute involving Business Logic, and a New York Attorney General matter involving retirement-plan advisory services. The filing states that outcomes cannot be predicted. Separate patent matters with Aloft Media and Online News Link were resolved through license agreements.
- Key operating risks include financial-market volatility affecting asset-based fees, competition and industry consolidation, reputational and fiduciary-liability claims, technology or database outages, non-U.S. operating challenges, foreign-currency exposure, and free or low-cost competing information.
- A November 2010 subsequent event involved the acquisition of the Annuity Intelligence business for $14.1 million, subject to post-closing adjustments.
Important Facts to Verify
- Whether acquisition-driven revenue growth can translate into improved operating margins as compensation, integration, and amortization costs rise.
- The sustainability of organic growth, particularly given declining U.S. Morningstar.com Premium subscriptions and the loss of GARS revenue.
- The final purchase-price allocations, goodwill and intangible valuations, and resulting amortization expense for 2010 acquisitions.
- The outcome and potential financial impact of the disclosed legal proceedings and ongoing tax audits.
- The effect of higher recurring dividends, potential share repurchases, additional acquisitions, and planned capital expenditures on cash balances.
- The company’s exposure to interest-rate and foreign-currency movements; management estimated that a 100-basis-point rate change would affect investment-portfolio fair value by approximately $0.8 million.