UNITED STATES
SECURITIES AND
EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13
or 15(d) of
the Securities
Exchange Act of 1934
Date of Report (Date of earliest
event reported):
December 4, 2009
MORNINGSTAR,
INC.
(Exact name of registrant as
specified in its charter)
Illinois
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000-51280
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36-3297908
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(State or
other jurisdiction
of incorporation)
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(Commission
File Number)
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(I.R.S.
Employer
Identification No.)
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22 West
Washington Street
Chicago, Illinois 60602
(Address of principal executive
offices)
(312) 696-6000
(Registrants telephone number,
including area code)
N/A
(Former name or former address,
if changed since last report)
Check the appropriate box below if the Form 8-K filing is intended to
simultaneously satisfy the filing obligation of the registrant under any of the
following provisions:
o
Written communications pursuant to Rule 425 under
the Securities Act (17 CFR 230.425)
o
Soliciting material pursuant to Rule 14a-12 under
the Exchange Act (17 CFR 240.14a-12)
o
Pre-commencement communications pursuant to Rule 14d-2(b) under
the Exchange Act (17 CFR 240.14d-2(b))
o
Pre-commencement communications pursuant to Rule 13e-4(c) under
the Exchange Act (17 CFR 240.13e-4(c))
Item 7.01. Regulation FD
Disclosure.
The following information is included in this Current Report on Form 8-K
as a result of Morningstar, Inc.s policy regarding public disclosure of
corporate information. Answers to additional inquiries, if any, that comply with
this policy are scheduled to become available on January 4, 2010.
Caution Concerning Forward-Looking Statements
This current report on Form 8-K contains forward-looking statements as
that term is used in the Private Securities Litigation Reform Act of 1995.
These statements are based on our current expectations about future events or
future financial performance. Forward-looking statements by their nature
address matters that are, to different degrees, uncertain, and often contain
words such as may, could, expect, intend, plan, seek, anticipate,
believe, estimate, predict, potential, or continue. These statements
involve known and unknown risks and uncertainties that may cause the events we
discuss not to occur or to differ significantly from what we expect. For us,
these risks and uncertainties include, among others, general industry
conditions and competition, including the current global financial crisis that
began in 2007; the impact of market volatility on revenue from asset-based
fees; damage to our reputation resulting from claims made about possible
conflicts of interest; liability for any losses that result from an actual or
claimed breach of our fiduciary duties; financial services industry
consolidation; a prolonged outage of our database and network facilities;
challenges faced by our non-U.S. operations; and the availability of free or
low-cost investment information.
A more complete description of these risks and uncertainties can be found
in our Annual Report on Form 10-K for the year ended December 31,
2008. If any of these risks and uncertainties materialize, our actual future
results may vary significantly from what we expected. We do not undertake to
update our forward-looking statements as a result of new information or future
events.
Investor Questions and Answers: December 2009
We plan to make written responses available addressing investor questions
about our business on the first Friday of every month. The following answers
respond to selected questions received through December 2, 2009. We intend
to answer as many questions as time allows, although we will not answer product
support questions through this channel. We may wait to respond to a given
question until the following month if we need more time to research the answer.
If you would like to submit a question, please send an e-mail to
investors@morningstar.com, contact us via fax at 312-696-6009, or write to us
at the following address:
Morningstar, Inc.
Investor Relations
22 W. Washington
Chicago, IL 60602
Business
Environment
1.
Overall,
the tone of Mr. Mansuetos comments in the 3Q earnings release seemed more
positive relative to the past few quarters or at least less negative. Should I
take this to mean that while there will likely be pressure on revenue growth
from weaker pricing power that generally you all feel better about
2010? How do sales pipelines in certain important products look to be
shaping up into the early part of next year?
2
We believe business conditions have
stabilized to some extent. Although organic revenue declined in the third
quarter of 2009, the rate of decline was consistent with the second quarter.
As we look toward 2010, we expect
that well begin restoring some of the benefits that we previously reduced in
2009 (such as partial matching contributions to retirement plans, tuition
reimbursements, and bonus expense), so our expense base may also increase as
revenue improves.
Our sales pipeline has improved
overall, particularly for products such as DataHub, a new service that
helps institutional clients consolidate their data
aggregation services and better manage data across their organizations,
and Licensed
Tools & Content (which includes our Site Builder platform), but other
products have remained under pressure.
2.
Please
speak about pricing in both businesses at the current time, particularly in
your Advisor products and Morningstar.com, both subscriptions and advertising?
Weve heard that data-oriented businesses that derive revenue from the
financial services industry, despite improvements in new sales, are being
offset by weaker pricing power on re-contracting. Do you plan to raise prices
on Morningstar.com premium subscriptions in the new year?
On the advisor software side, most
of our existing clients are no longer requesting price concessions driven by
difficulties in their business results. Weve implemented some small fee
increases, although our clients generally remain price sensitive.
Fee pressures for new customers have
also lessened, although weve also found that new clients typically have
smaller budgets to work with than in the past. If a client has a limited
budget, we can typically configure an appropriate solution to meet its budget
needs.
With Morningstar.com, we were not
immune to the industry-wide pricing pressure in the first half of the year.
That said, we were able to maintain price integrity for the high-demand areas
of the site, while reducing pricing for some other areas. That pressure has
abated more recently, and weve been eliminating some of the discounting from
earlier in the year.
We do plan to implement a modest
price increase (albeit smaller than in the past) for Premium memberships in January 2010.
Operating Metrics
3.
Internally,
do you target a specific ROE or do you generally look more at operating income
growth, margins, and top-line growth?
We dont have a specific target for
ROE (return on equity). The three key operating metrics that we focus on are
revenue, operating income, and free cash flow. Our goal is to increase the
intrinsic value of our business over time, which we believe is the best way to
create value for our shareholders. We believe these measures can help investors
generate their own assessment of how our intrinsic value has changed over time.
Operating
Metrics/Bonus Plan
4.
Which
operating metrics are most important in determining managements compensation
(bonus)?
3
The size of our bonus pool has
historically been driven by changes in operating income relative to the
previous year. As part of the cost-cutting measures we implemented in early
2009, we made a number of changes to this years bonus plan, including reducing
the overall size of the bonus pool relative to previous years.
Acquisitions
5.
In
a prior filing you seemed at least open to a larger opportunistic acquisition
should the right deal present itself? Generally, is the idea of diversifying
either geographically, via product set, or to a different set of clients where
you may be under-represented the main driver? Or is cost savings?
Yes, weve said in the past that while we like smaller bolt-on
acquisitions, we wouldnt rule out a larger acquisition if the right
opportunity presented itself. We evaluate potential acquisitions based on a
number of metrics, including cost savings and diversification value. Most
important, though, our goal is to ensure that acquired operations are a strong
fit with our five key growth strategies, which are:
·
Enhance our position in each of our
key market segments by focusing on our three major Internet-based platforms;
·
Become a global leader in
funds-of-funds investment management;
·
Continue building thought leadership
in independent investment research;
·
Create a premier global investment
database; and
·
Expand our international brand
presence, products, and services.
6.
What
are some of the most intriguing acquisition opportunities that you all see in
international fund markets right now?
As a matter of policy, we dont
comment about our acquisition pipeline.
Morningstar.com
7.
How
have the new trial starts trended in Morningstar.com over the past few months?
Has the trial-to-paid conversion rate remained relatively consistent?
In the third quarter of 2009, new
Premium trial starts remained weak, which we attribute to continued pressure on
consumer discretionary spending. However, the trial-to-paid conversion rate
improved during the quarter.
8.
Would
you say its fair to say that the strong growth in registered users on
Morningstar.com should provide the gasoline, so to speak, for future growth in
premium subscribers on the other side of this crisis? How should I be looking
at growing registered users (i.e. increased foot traffic) in the context of shrinking
premium subscribers?
Registered users are an important
driver behind future growth in Premium subscribers. Registered users represent
a significant portion of our Premium trial pipeline, with the remainder from a
mix of traffic sources including returning visitors, organic search engine
traffic, syndication referrals, and new visitors. However, theres not always a
direct correlation between signing up as a registered user and being willing to
pay for a Premium membership.
4
Credit Ratings
9.
I saw the announcement this morning about the new bond ratings service.
Can you please clarifyhow will you be charging for the service?
We charge subscription fees to institutions to access the
complete credit research and models that go into our credit ratings.
Institutional investors who subscribe to these services will be able to access
all of the research behind the ratings, which includes written credit research,
cash-flow models, and investment recommendations as well as access to the
analysts.
10.
What is the incremental cost to your credit-rating effort and what is
your sense for incremental revenue?
The credit-rating effort leverages
the work of our equity analyst staff, and our credit ratings are driven by the
same fundamental cash-flow forecasts we use to generate our ratings on stocks.
In addition, we plan to hire a total of about 10 fixed-income specialists
dedicated to producing credit ratings. We dont provide estimates for
incremental revenue, but we believe theres a market need for multiple
perspectives on issuers credit quality. As a leading provider of independent
investment research, we believe we have a unique viewpoint to offer on company
default risk that leverages our cash-flow modeling expertise, proprietary measures
like Economic Moat, and in-depth knowledge of the companies and industries we
cover.
11.
Given the current regulatory climate, it seems ratings agencies are
going to be much more vulnerable to litigation when their ratings prove
incorrect. Would this service leave you vulnerable to similar risks?
The regulatory landscape in the
credit ratings and research area is rapidly shifting, and well continue
monitoring the risk of litigation in all areas of our business.
12.
Previously, you said credit ratings was simply a tough model with a
conflicted issuer-pay structure and limited ways to get paid outside of that
structure. What made you reverse that stance? The main question here is
probably this: It seems like there is significant potential risk to offering
credit ratings, but somewhat limited reward in terms of additional sales? Why
is that premise incorrect?
Weve said for some time that it
would make sense for Morningstar to have a voice in this area. Its a natural
extension of the equity research weve been providing for nearly a decade. It
has taken us time to build established relationships with institutions that set
the stage for monetizing our research.
We think theres investor demand for
good, independent credit research, although the subscription-paid market isnt
as large as the issuer-paid market dominated by the three largest rating
agencies. Offering credit ratings is also a natural extension of the
Morningstar brand and will enhance all of our major platforms. Because of our
experience with our institutional equity research service, we believe we have
the relationships and platform in place to monetize investment ideas and
research on bonds as well.
Morningstar Equity
Research
13.
What is your outlook for headcount in research? Has the analyst ranks
basically been reduced to their run-rate given the lower GARS revenue or will
more reduction be made in this business?
Our research headcount is driven by
what we believe is an optimal coverage list size and other research initiatives
that will drive the business going forward. We currently have approximately 80
stock analysts in the United States and plan to hire about 10 credit
specialists. We believe thats a representative size for the run rate of our
research team and will allow us to maintain one of the
5
broadest coverage universes of any
independent research firm in the world, although the size of the staff can vary
based on attrition as well as business demand.
Morningstar Investment
Research Center Contract with U.S. Department of Defense
14.
Regarding this Department of Defense mandate, what type of revenue
impact should we see from this? What was the value of revenue derived from the
Navy relationship prior to this signing? Are there other types of
opportunities you are seeing to provide bulk coverage of one of your products
across an organization, financial or otherwise?
We recently announced an agreement
with the U.S. Department of Defense to offer our proprietary investment
research and tools to all military service personnel and their families
worldwide. Were providing this research through the Morningstar Investment
Research Center, which includes research and analytical tools from our retail
Web site, Morningstar.com.
Although this agreement
significantly expands our previous relationship with the Navy, we dont expect
it to be material to our overall results.
We have bulk coverage agreements
similar to these in place for several other products and services, and were always
looking for opportunities to develop new enterprise-wide agreements.
15.
Is the DoD offering research to all military personnel, rather than
just the account with the Navy, a replacement of some of the revenue lost due
to the end of the GARS? If so, what percentage of that lost revenue do you
anticipate this deal will replace?
As mentioned above, the research were
providing is through the Morningstar Investment Research Center and isnt
related to the research we provided related to the Global Analyst Research
Settlement. The contract value for this agreement isnt material to our overall
results.
Morningstar Advisor
Workstation
16.
In your Advisor Workstation product, can you tell me how much business
you do with the three-headed oligopoly of Morgan Stanley Smith Barney, Bank of
America-Merrill Lynch, and Wells Fargo-Wachovia? Do these companies typically
utilize in-house software rather than your product? Are you noticing as
dislocation related to M&A in the advisory space continues, albeit at a
slowing rate, that MORN is benefiting either from brokers joining smaller firms
that utilize your product, or in any other manner?
We estimate that less than 10% of
our advisor software revenue came from these three firms in 2009. Brokerage
firms such as these typically use both in-house software and some outside
resources. Regarding your question on dislocation related to M&A,
consolidation among our clients often results in some overlap of services,
which can translate into a near-term reduction in fees if we reprice our
current services to eliminate any overlap. In some cases, were later able to
initiate conversations about expanding the range of services for the combined
firm, so ultimately the relationship may be larger once the merger dust
settles.
We have noticed some benefit from
brokers moving to smaller firms. Anecdotally we know that some portion of the
growth in Morningstar Office (previously Morningstar Advisor Workstation Office
Edition), in particular, is the result of the trend of wirehouse brokers breaking
away and moving to an independent model. We believe Office is well-suited to
their needs because of its capabilities as an end-to-end solution for
independent practice management.
6
Morningstar Site
Builder
17.
Can you provide the number of Site Builder licenses outstanding at the
end of 2Q and 3Q?
Because Morningstar Site Builder is
now part of our Licensed Tools & Content product line, we dont plan
to break out the number of licenses for this product going forward. We believe
that the number of licenses is a less meaningful measure of business size in
this area, which is one reason we now distinguish it from the Advisor
Workstation metrics. Because Site Builder tools are often used by our clients
to enhance the content/capability of a high-traffic or public-access Web site,
we frequently license Site Builder tools on a site license rather than a
per-seat basis. We establish a flat site license price based on the relative
value of the Site Builder configuration as well as an estimate of the level of
distribution, but the price is not directly related to a fixed number of
expected users or seats.
Morningstar Direct
18.
Can you discuss a bit about Morningstar Direct subscription growth,
particularly international? What types of financial institutions continue to be
most interested and capable of committing to new spending in this product?
Were seeing continued growth and
strong interest in Morningstar Direct from asset management firms, banks, and
investment consultancy firms outside the United States. The majority of our
clients are sales and marketing professionals, but we also reach some portfolio
managers and research analysts internationally. With the continued expansion of
our global databases and recent enhancements such as portfolio attribution,
performance reporting, and the presentation studio, were also seeing new
business in the pensions/insurance, investment consulting, and private wealth
segments. In addition, were working on developing new opportunities with
small- to mid-size asset management firms that are seeking to reduce costs by
consolidating their research with one provider. Morningstar Direct has been
well-received in these areas because its an all-in-one research solution, and
we can easily deploy it across teams.
Reseller Agreements
19.
Regarding the outsourcing agreement announced with Advent Software and
Global Industry Classification Standard (GICS) on November 19, 2009, what
is Morningstars role? Is this a revenue-generator or is there a cost related
to the agreement? Is this the first time you have worked with Advent Software?
How does this agreement change the competitive dynamics (or not change) between
Advent and Morningstar? Some elaboration would be helpful. Does Morningstar
have any other relationships/agreements with others, such as FactSet?
We recently renewed our agreement
with Advent to continue providing the company with data on fund
classifications, as weve done in the past. There are many companies that we
compete with in some areas but also work with as clients. Because our data on
fund classifications is viewed as the industry standard, its an opportunity
for us to generate revenue as well as expand distribution for Morningstars
data and branding. We have numerous reseller agreements similar to these with a
variety of other companies, and we dont view them as problematic from a
competitive perspective.
Investment
Management Segment Operating Margin
20.
How much operating leverage exists in the investment management
segment? It seems to me your margins in that business are already so high that
beyond a modest amount of room for margin improvements there may not be much
more given the compensation structure in the investment management industry.
Where do you see margins in that
7
segment long-term assuming the current suite of businesses there
remains static (which I admit is a bad assumption given your growth
strategy)? Any color would be helpful.
Because we dont give financial
forecasts, we cant give you a projection for long-term operating margins in
this segment. Its fair to say that this segment has significant operating
leverage, which magnifies the impact of revenue gains and losses on operating
income.
Investment
Management Segment Asset Flows
21.
Could you update us on flows to, most notably, Morningstar Associates
fund-of-funds and INTECH? What about flows to Morningstar Managed Portfolios
during 3Q? Generally, what is your outlook for RFP pipelines, are they picking
up at all? Color on new business trends in investment management would be
helpful.
In the third quarter of 2009,
Morningstar Associates had slightly positive net inflows, but that was more
than offset by the impact of two client non-renewals, one in October 2008
and the other in May 2009. Intech had small outflows during the quarter,
which were offset by the positive impact of market performance. Morningstar
Investment Services (which offers Morningstar Managed Portfolios) had positive
inflows during the quarter.
22.
I calculate about a 25 basis-point fee rate for INTECH, is that about
[in the right] ballpark?
We quote expense ratios in our
offering documents for the Intech portfolios, and management fees typically
range from 0.35% to 1.28% of the amount invested in a trust. Out of this fee
Intech pays the underlying investment managers and operating expenses of the
trusts. While the fees quoted are indicative, many of our assets are placed at
an institutional level with specific rates negotiated, so the overall amount we
receive depends on the asset class a client invests in and the overall level of
investment.
23.
Any plans to diversify product offerings in investment management into
more absolute return-oriented strategies that may include long/short equity,
arbitrage, or other alternative products?
Yes, were interested in expanding
our capabilities in these areas. For example, we recently hired a head of
alternative investment strategies for Morningstar Associates, and we currently
subadvise on an alternative strategies portfolio (Transamerica Alternative
Strategies). Our Intech subsidiary in Australia offers three alternative
strategy portfolios, and weve also been increasing our research efforts in
these areas at Ibbotson Associates.
Investor
Communications
24.
Any plans to loosen your communication procedure with investors? I
understand and respect your wishes to communicate with all investors equally,
but it would certainly be helpful to get incremental color via the phone (for
sell side analysts such as myself) or even via conference calls following
earnings. For what its worth, I think it would help investors more effectively
understand your business in real-time.
Thank you for the comments. We feel
strongly about providing equal access to information to all investors, so we
dont anticipate changing our policy to start holding one-on-one meetings or
conference calls. That said, we encourage anyone interested in learning more
about our business results and strategy to attend our annual meeting, which is
held in Chicago each May and includes presentations about our business and
an extensive Q&A period with management.
8
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
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MORNINGSTAR, INC.
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Date: December 4, 2009
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By:
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/s/ Scott Cooley
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Name:
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Scott Cooley
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Title:
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Chief Financial Officer
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9
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