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):
August 6, 2010
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
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Chicago, Illinois
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60602
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(Address of principal executive offices)
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(Zip Code)
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(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 September 3, 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 current global financial uncertainty; 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, 2009. 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: August 2010
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 August 2, 2010. 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
Morningstar Rating for Mutual Funds
1.
The
usefulness of your star ratings for mutual funds was recently criticized in a
study that got some pressessentially it seems the critique noted that 4- and
5-star funds in some
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recent periods have struggled. Various
studies in the past have made similar observations, noting that a high star
rating doesnt necessarily presage above-average returns, etc. This gets
partly at the crux of your ratingsi.e. they are backward-looking gauges of
past risk-adjusted performance and arent presented as a predictor of future
performance.
Given the sway your ratings have in fund
saleswhere investors are clearly trying to gauge future returnshave you
considered tweaking your star ratings or launching a different forward- looking
gauge? Obviously this is a tall orderpredicting future investment returns is a
big business and most people still trail passive indices over timebut it would
be helpful to know how youre thinking about the positives/negatives of your
rating system for U.S.-based funds, particularly now that you have different,
subjective ratings launched outside the U.S. Is the star rating due for an
overhaul? Are you planning to create broader subjective ratings in the U.S.?
How do fund picks/pans, stewardship grades and other metrics factor into the
broader job of rating thousands of funds?
Your
question raises several different issues, so well try to tackle them in
roughly the same order. First, we take issue with the most recent study
regarding the performance of the star rating. Specifically, we believe the
study you are referring to was based on our previous star rating methodology.
We made significant changes to the rating methodology in 2002, and these
changes werent reflected in the study.
Second,
you are correct that we dont claim that the Morningstar Rating is a predictor
of future performance, particularly in the short term. The Morningstar Rating
is a quantitative, backward-looking measure of risk-adjusted returns. The
ratings offer a quick summation of favorable attributes, and, as such, form a
better starting point for fund research than the short-term raw performance
numbers that investors formerly used as their primary research tool.
We regularly
publish information about how the Morningstar Rating for funds has performed on
Morningstar.com.
Weve
always emphasized that the Morningstar Rating is meant to be an introduction,
not a conclusion. Investors have more than 7,000 funds in the United States to
choose from, and we believe the star ratings are useful as a first-stage screen
to narrow the field. The star rating helps identify funds that have
historically had lower volatility, better performance, and lower costs than
their peers.
Third, its
worth pointing out that the star rating has historically done a decent job of
predicting future long-term performance since the methodology revamp in 2002.
Across all fund types, higher-rated funds outperformed lower-rated funds for
most five-year buy-and-hold periods during the mid and late 2000s. The gap
widens if survivorship is considered, as lower-rated funds have been much more
likely to be merged out of existence.
Because we
view the Morningstar Rating as a starting point, we devote significant
resources to producing qualitative research that goes well beyond the rating.
We believe this qualitative research is ultimately more valuable to investors.
We have 94 fund analysts around the world who conduct in-depth research on more
than 3,500 funds globally. To research funds thoroughly, our analysts dig into
mutual funds underlying portfolio holdings and investment styles, interview
portfolio managers, conduct quantitative analysis using our databases, and
monitor regulatory information. We produce a variety of qualitative research,
including analyst research reports intended to help individual investors and
advisors better employ funds in a
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portfolio,
Stewardship Grades, Fund Picks and Pans, fund family reports, target-date fund
family research and reports, and more. All of this qualitative output captures
important fundamental information not included in the Morningstar Rating. In
particular, our US Fund Analyst Picks, which we have produced for more than a
decade, are meant to steer investors toward funds that we believe have the best
prospects for the next 10 to 20 years.
In
addition we offer explicit qualitative ratings in many markets outside the
United States, including Australia, Asia, and Europe. Like our US qualitative
research, these ratings are based on our analysts conviction in the funds
ability to outperform its peer group over the long term. We currently produce
Qualitative Ratings on approximately 1,000 funds based outside the United
States. Were always looking for ways to enhance our research and are
evaluating the possibility of introducing a similar system in the United
States.
Regarding
the last part of your question, we describe how we advise investors to use the
Morningstar Rating, picks and pans, and other Morningstar research at
Morningstar.com.
Sales Environment
2.
At the
annual meeting, you said institutional customers morale/demand seemed to have
bottomed roughly in the middle of last year. Is that still your view? Has the
sovereign debt crisis in Europe and concerns about the US economys recovery
led institutional customers to pull back again? Clearly hard to answer, but it
would seem that incrementally there are likely signs that customer budgets are
on the mend or shrinking again. Any and all insight would be appreciated.
Weve
continued to see gradual improvement in the sales environment. Although some
clients are still cautious about global economic growth or other issues (such
as the potential impact of the financial regulatory reform bill), the business
climate generally seems to be gradually improving. Weve continued to
experience some cases where clients are under budget constraints or need to
defer contract signings, but overall, our clients seem more engaged in sales
discussions and more interested in initiating new projects.
Operating Costs
3.
The employee bonus expense looks like the
driver for your lowered margins and lower EPS. Is this a one-time increase
because of a reduction in 2009? Or, are we back to more normal levels for these
expenses going forward?
You are
correct that the increase in bonus expense contributed significantly to our
lower operating margin and earnings per share in the second quarter of 2010.
Our bonus expense in the past quarter was $9 million, an increase of about $5.4
million from the previous year. Our second quarter operating income declined
about $5 million on a year-over-year basis. Many factors affected our operating
margin during the quarter, both positively and negatively, but the bonus
expense was a key contributor to our operating margin decline.
The
increased bonus expense primarily results from the restoration of part of the
bonus pool that we cut in 2009. Last year we reduced our bonus expense as part
of our efforts to better align costs with revenue in a challenging business
environment. As business conditions have improved, as evidenced by our return
to positive organic revenue growth, we have restored a portion of what was cut.
Acquisitions also contributed to the increase in bonus expense.
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In the
past, growth in operating income has been the primary driver of changes in the
level of our bonus expense. We cannot make long-term guarantees about what our
bonus plan will look like, but in the near term, we expect that changes in
operating income will once again be the key factor driving changes in our bonus
expense.
4.
What do
you expect going forward as a more normal operating margin? Operating margin
decreased from 27.3% to 20.3% YoY.
We dont
make predictions about our future financial performance, but we do believe that
our business has significant operating leverage. We make significant
investments in key capabilities such as research, data, and software, and incremental
sales of these products tend to be very profitable. To the extent that our
revenue continues to recover, we would expect that, ultimately, our margins
will benefit.
5.
Could
you talk about your new commission plan? It appears the expense is now recorded
in the quarter of the sale instead of over the term of the contract. Can you
talk about why you have done this and how it should change your income
statement and margins?
Early this
year, we adopted a new U.S. sales commission plan that, as you point out,
results in our recording sales commission expense during the quarter, rather
than over the life of the contract.
The intent
of the new plan is to reward our sales team for increasing our book of
business, which is effectively our annualized revenue run rate. To the extent
that sales representatives increase their book of business, our annualized
revenue increases, and both the company and our sales representatives will
benefit. The previous sales commission plan was based on total contract value
and, while generally effective, lacked a direct link to annualized revenue.
Although
we expect the implementation of the new plan to be cash-flow neutral, compared
to the former commission program, it has increased our reported commission
expense in the short term. In addition to expensing the commissions
immediately, instead of over the life of the contract, we are continuing to
record expense related to contracts signed under the former plan. This expense
will diminish over time, as contracts signed under the former commission plan
expire.
Over time,
we do not expect that the new plan will increase our sales commission expense
as a percentage of our revenue.
6.
It looks
like health-care costs, 401(k) contributions and sales commission expense
all rose during the quarter. What do you see going forward with these costs?
Basically, were all of these costs, including your bonus expenses, higher for
this quarter relative to what we will see going forward, or will these
reinstatements of costs continue going forward and have a downward
pressure on margins?
With
respect to the long-term implications for margins, we view the 401(k) contributions
and health-care costs distinctly from one another. (We have discussed the bonus
and sales commission expense above.)
We expect
that the partial restoration of our 401(k) match will affect our costs in
the long term, and in fact, it is our intention to restore a full 401(k) match
as soon as business conditions allow it. Morningstar has historically offered a
7%, dollar-for-dollar match on employees 401(k) contributions. As part of
our cost-cutting efforts in 2009, we suspended the 401(k) match. This year
we have restored a 50% match on contributions. Morningstar strongly believes in
the
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importance
of a meaningful 401(k) match and considers our historically generous match
to be a competitive advantage when trying to recruit and retain employees.
With
health care, our costs rose sharply in the second quarter, in large part
because of a relatively small number of large claims. Morningstar self-insures
for medical claims (though we buy a stop-loss policy that prevents us from
suffering huge losses in this area). As a result, our health-insurance expenses
can change from quarter to quarter, based on employees medical claims during
the period. Based on our previous experience, we consider this number of
large-dollar claims to be exceptional, though we recognize that in general,
health-care costs are rising.
Acquisitions
7.
It looks
like acquisitions are a key growth factor for your company, at least recently.
Do you see more acquisitions in the near future? Are there any organic growth
drivers that you see having a positive effect on your company?
It is true
that Morningstar has completed a number of acquisitions in recent years. We are
willing to consider acquisitions that are consistent with our key growth
strategies, provided that the transaction is reasonably priced.
We believe
our core business is very strong, however, and because of that, we dont need
to consummate acquisitions to grow. In the second quarter, our organic revenue
grew, despite the loss of $5.4 million of revenue related to the Global Analyst
Research Settlement (GARS), which expired in July 2009. Due to that strength in our core product
lineup, we can be very selective on the acquisition front.
A number
of our products are performing well and have bright prospects, but three of
them really drove our revenue growth in the second quarter. Morningstar.com
recorded a strong revenue increase in the past quarter due to a recovery in
Internet ad spending. Morningstar Direct, our global institutional research
platform, continued to post strong growth. In fact, during the quarter we set a
new record for the net number of new licenses for Morningstar Direct. Finally,
Retirement Advice notched strong growth in the period, driven by the recovery
in equity markets.
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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:
August 6, 2010
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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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