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):
November 5, 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 December 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: November 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 November 3, 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
Recent
Initiatives
1.
Can you update us on some new initiatives on
the website, in particular, and also the investment data business more broadly?
Here are
some of the major initiatives weve introduced recently for Morningstar.com:
2
·
Launched a
new Premium service for investors in Canada
·
Launched a
new mobile application for the BlackBerry
·
Created
sponsorships opportunities for exchange-traded fund (ETF) centers on retail
sites in the United States and across Europe, including online advertising,
conference calls, and ETF seminars in eight locations
Weve also been working on many
other initiatives in other areas of the Investment Information segment. Here
are some of the highlights from the past six months or so:
Data
·
Launched a
new, customizable version of Morningstar Document Library
·
Launched
point of sale product for standard fund reports that meets new Canadian
regulatory requirements for a simplified document that replaces the prospectus
·
Completed
our Chilean and Mexican fund databases
·
Set up a
new Asian network for real-time data, installing Hong Kong and Tokyo data
centers in July
·
Released
new ETF institutional data points, including tracking error, daily alpha before
expense, market impact, and concentration risk
·
Began providing earnings conference call transcripts on 750 U.S.
companies
·
Added other equity data to database, including corporate events and
earnings estimates
·
Launched
two new indexes that track the performance of Master Limited Partnerships
Software
·
Rolled out several enhancements for Logical Information Machines (a
leading provider of data and analytics for the energy, financial, and
agriculture sectors that we acquired in December 2009), including a new
data delivery warehouse, a new set of application programming interfaces (APIs)
and continued improvements on existing APIs, and an Excel add-in application
that facilitates data extraction
·
Launched a new service within Morningstar Office called Report Studio to
serve the custom portfolio reporting needs of advisors
·
Created a system that facilitates Morningstar Advisor Workstation
integration with a clients advisor platform, enabling data-sharing between the
two platforms
·
Began commercial launch of Morningstar QuoteSpeed 2.0 via
direct-to-advisor sales
Research
·
Expanded fund analyst coverage on funds based in Europe and Asia,
crossing the 1,000 rated funds mark
·
Launched analyst research on closed-end funds and introduced Closed-End
Fund Weekly newsletter
·
Hosted our
first Morningstar ETF Conference
·
Launched
ETF Research in Canada and Australia
·
Launched Morningstar Newsletter Builder, a tool that allows advisors to
generate their own branded client newsletters incorporating Morningstar content
·
Through
Realpoint, began developing our new residential mortgage-backed security (RMBS)
platform
·
Increased
corporate credit ratings to 600 and began delivery of analyst research reports
to our first credit-only client
3
Data
Business
2.
To what extent are your clients, existing
and/or prospective, focused on consolidating data providers? Has this
generally benefitted your or hurt your business?
Weve seen
more interest in consolidating data sources, which has generally worked in
Morningstars favor. Our data coverage on managed investment products is tough
to match. We also have strong coverage of equities and can often meet a companys
needs for that data as well. Because of
these strengths, we often gain business when our clients consolidate data
providers. Even in cases where a competitor offers one of its data sets at a
discount, we often end up winning the consolidated business because of the depth
and breadth of our data coverage, especially on open-end funds.
3.
What other asset type or investment
databases do you feel under-penetrated or feel the product can be enhanced from
where it is today either through organic growth and/or acquisition?
Our major
area of focus is managed investment product data. We believe we still have
significant potential to expand our reach with clients outside the United
States as well as with client segments we havent historically focused on, such
as compliance, investment management, trading, research, and quantitative
functions. We continue to work on building up our fundamental equity data,
where we see a large market opportunity. Were also interested in providing our
clients with access to additional fixed-income data.
In
general, we believe we already have fairly broad investment data coverage that
meets most of our clients needs; however, were always open to adding
additional data sets in related areas, such as private equity, derivatives,
alternative investments, and structured products.
4.
Do you have any incremental plans for
additional ETF launches? What types? What regions?
Were
planning to expand our global equity indexes, including a family of European
style indexes as well as regional and country indexes for other major markets.
Many of these indexes could be licensed to serve as the basis for an ETF,
although we dont have any immediate licensing plans.
Morningstar.com
5.
Can you provide a time series back to your
S-1 filing showing monthly annual, 2-year, and 3-year pricing to the website?
Can you also remind me what percentage of your revenue, roughly, has come from
advertising versus websites?
The table
below shows pricing for Premium membership subscriptions over the past six
years.
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2005
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2006
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2007
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2008
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2009
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2010
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Monthly
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$
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13.95
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$
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14.95
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$
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15.95
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$
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16.95
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$
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18.95
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$
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19.95
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Annual
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$
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125
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$
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135
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$
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145
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$
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159
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$
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174
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$
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179
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Two Year
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$
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209
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$
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225
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$
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245
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$
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269
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$
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289
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$
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299
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Three Year
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$
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299
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$
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320
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$
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345
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$
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369
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$
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389
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$
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399
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On
average, Premium subscriptions have generated about 70% of the sites revenue,
with the remaining 30% from internet advertising sales.
6.
What kind of pricing power do you anticipate
in this business over the next 3-5 years from both a subscription and
advertising perspective? Is the pricing strategy an inflation or
inflation-plus focus or is it about increasing the functionality/data/general
breadth of everything and expanding the pricing power therein?
4
In
general, our pricing strategy is to continuously enhance the depth, breadth,
and functionality of the data, analysis, and tools we provide on
Morningstar.com. Because were always improving and expanding the site, we
believe were in a better position to make moderate price increases each year
for Premium membership. We also strive to continuously enhance the value of the
site for advertising sales placements, which helps us sustain pricing relative
to competing sites.
However,
its tough to say what our pricing power may be going forward because it partly
depends on factors outside of our control, particularly with Internet
advertising sales, which is a heavily cyclical business. With Premium
memberships, our ability to raise prices may vary depending on consumer
discretionary spending, general economic trends, and competitive factors.
7.
How many different countries and/or
languages do you operate a Morningstar.com or like website today?
We
currently have about 40 websites for individual investors around the world.
8.
Can you talk about some of the metrics you
look at, such as trial to paid and other relevant ones, and how theyve been
trending? What are some of the indicators you all look at as they may be
correlated with activity on your website?
We look at
several different metrics for Morningstar.com Premium memberships, including
free registrations, Premium trial starts, the trial-to-paid conversion rate,
and cancellations. On the positive side, free registrations trended up during
the third quarter, and the cancellation rate declined. However, Premium trial
starts and the trial-to-paid conversion rate have not significantly improved.
We also look at general indicators of interest in the site, such as unique
users and pages views, both of which declined in the third quarter. We
believe this reflects an industry-wide trend for investment-related websites,
which have had lower levels of user engagement in the wake of the financial
crisis and continued economic weakness.
Advisor
Software
9.
How has the top-of-the-market consolidation
(the big getting even bigger) in the North American FA/brokerage business
impacted your business, positively or negatively?
Industry
consolidation in the financial services sector has been an ongoing trend, and the
effect on us varies from case to case. We may lose business following an
acquisition of one of our clients, but we also often have opportunities to
continue providing services or expand our business with the new parent
organization. For example, we previously had separate agreements with two large
broker-dealer firms that have now combined their operations. Upon renewal, the
contract value revenue increased. In other cases, user counts have declined
following mergers, so it can work both ways.
10.
Are you
continuing to see a trend of financial advisors breaking away from the larger
wirehouses and as a result adopting more holistic practice management-focused
products and services?
Yes, weve
continued to see more financial advisors moving to become independent, which
has helped create demand for Morningstar Office, our comprehensive practice and
portfolio management system for independent financial advisors.
5
11.
Who would you
say is your most challenging competitor in this business? How so, is it
based on price? With the recent IPO of Envestnet as well as others focused on
the space, have you noticed an increase in pushback of price at all from
prospective clients?
We havent
identified a most challenging competitor, but weve identified the companies
below as firms that we compete with in the advisor arena:
Morningstar
Advisor Workstation and Morningstar Office: Advent Software, Advisor Software
(ASI), Albridge Solutions, Interactive Advisory Software (IAS), Schwab
Performance Technologies, SunGard, and Thomson Reuters.
Site
Builder and Licensed Tools: Interactive Data Corporation, QuoteMedia, Thomson
Reuters, and Wall Street On Demand.
Morningstar
Managed Portfolios: Brinker Capital, Curian Capital, Envestnet PMC, FundQuest,
and SEI Investments.
With
respect to pricing, our clients have had ongoing budgetary constraints, but we
havent seen increased pricing pressure related to a specific competitor.
12.
Is it
commonplace in the industry if you sign an enterprise client to Advisor
Workstation that there will be some exclusivity for that relationship? Or
generally the advisory firm can sign contracts with as many providers as they
wish (although may not be economically prudent to do so) and those individual
FAs that want to use your product or another can do so at their discretion?
Our
enterprise agreements vary by firm or type of firm. Some firms require
their advisors to use a standardized set of tools, often including Morningstar,
provided through the firms home office. Other firms offer tool options
that may include Morningstar but dont require their advisors to adopt those
solutions. In these cases, its up to the individual financial advisor to
decide if Advisor Workstation is right for his or her needs.
13.
How many
total enterprise relationships do you have and is there a noticeable proportion
of renewals over the coming year or so? How do renewals work? Are
they run at the organization level and then the financial advisors follow suit or
is directly to the user? Have you ever lost an enterprise relationship at
the institution level? If so, what caused this and was it a reason other
than consolidation within the financial services sector?
With
respect to our financial advisor solutions, we had more than 400 enterprise
clients globally as of September 30, 2010, with about half of our
contracts with these clients due for renewal in 2011. We negotiate renewals for
enterprise deals at the organization level and do not typically involve the end
users of the product. We have lost some enterprise deals for reasons other than
consolidation within the financial services sector, such as client budget
constraints.
14.
What is
the average contract length? How has that evolved over time? Do
larger organizations usually receive breakpoints in pricing assuming a certain
minimum level of users?
Our
average enterprise contract length is about two years and has remained stable
over the past few years. We have
tiered
pricing available for our enterprise products based on a clients level of
commitment in terms of number of users or financial minimums.
6
Morningstar
Direct
15.
Can you
describe in more detail the functionality on the Morningstar Direct product and
how this has evolved over time? Since it used to be called DataLab Im
assuming its heritage is more as a data portal that has been enhanced over time
with various modules to increase value to the user as well as pricing for
Morningstar? Do you partner with other third-party providers, say a
RiskMetrics for portfolio attribution as one example, rather than develop some
of this functionality internally? Just trying to get a better sense of
this product, its historical and prospective evolution from a usage and
functionality standpoint, and how that might impact price as well as
positioning in the institutional data/investment tools marketplace.
Morningstar
Direct is our Web-based institutional research platform providing advanced
research on the complete range of securities in our global database. Through
this platform, we provide access to all Morningstar data for one price,
including the data behind our proprietary statistics, such as Morningstar
Ratings, the Style Box, Morningstar Category, and Institutional categories.
Morningstar Direct currently includes data on open-end funds, stocks,
closed-end funds, insurance/life funds, exchange-traded funds, separate
accounts and collective investment trusts, hedge funds, stock and fund
ownership and portfolio data, and financial filings. We also provide access to
a variety of third-party data, including global indexes, security identifiers,
and user-imported data.
Since
introducing Morningstar Direct in 2001, weve continuously rolled out new
features and functionality, which we typically develop internally. Some of the
functionality weve added over the past several years includes performance
attribution; holdings- and returns-based style analysis; estimated net flows,
assets under management, and market share data; a presentation studio interface
for creating customized reports; and additional data on offshore funds and
other investment types. Weve also continuously expanded the range of data
covered in Morningstar Direct with new databases and deeper coverage on
existing databases.
Credit
Research and Ratings
16.
How is
MORN involved in the conversation regarding the future structure of the
fixed-income rating business, either from an industry or regulatory standpoint?
For the
most part, we havent been directly involved in conversations with regulators
regarding the future structure of the credit rating business. However, we have
been actively building relationships with industry leaders and sharing our
perspective on the structure of the industry and more specifically, the role of
independent research firms such as Morningstar. We also contributed to a
National Association of Insurance Commissioners (NAIC) working group hearing in
September 2009 and presented our thoughts on recommendations and alternatives
to how the NAIC uses credit ratings.
Realpoint,
which we acquired in May 2010, has been actively involved in lobbying
efforts to help frame future credit rating policies and remain informed about
the current regulatory environment.
Investment
Landscape
17.
I
realize that you have robust data/research capabilities away from the mutual
fund heritage, but interested in your thoughts with an industry shift well
underway away from the active-only mutual fund managers. How you are
repositioning the business (website and/or in other parts of your company)
particularly as it relates to the market shift towards passive management of
assets as well as ETFs?
7
ETFs have
been a clear growth area, and weve invested significant resources in our ETF
analyst team. We currently have about 16 ETF analysts globally covering
approximately 400 funds. Weve also seen strong investor interest in
alternative investments, including hedge funds and mutual funds that incorporate
alternative strategies, such as 130/30 and absolute-return funds. We have
several analysts focusing on these alternative portfolios.
In
addition to growth in ETFs and alternatives, were seeing strong investor
interest in target-date and target-risk funds, risk-managed and
volatility-controlled portfolios, and solutions that combine asset allocation
and insurance. Weve added tools and capabilities across the business to meet
demand in these growing areas.
Investment
Management Segment
18.
What is
your appetite for additional acquisitions of investment managers? What would be
your greatest impetus to purchase another asset manager is it about expanding
the product set, geography, client list, and/or a combination of all of the
above?
One of our
key growth strategies is to become a global leader in fund-of-funds management,
so we would consider additional acquisitions of investment managers if we felt
they were a good fit for us. Since mid-2009, we have acquired three firms with
significant investment consulting businesses: Intech Pty Ltd in Australia (June 2009),
Old Broad Street Research Ltd. in the United Kingdom (April 2010), and
Seeds Group in France (July 2010).
We made
these acquisitions for a variety of reasons. We believe each firm represents a
strong cultural and investment-process fit with Morningstar. Each also
bolstered our investment consulting presence in one of the largest managed fund
markets in the world. And finally, all of these firms have developed important
client relationships that it would have taken many years for us to build on our
own. In the future, we would consider making additional acquisitions in this
space if they met these criteria.
19.
What is
your appetite for a fund-of-hedge-funds type product that would seem to leverage
your HF data and fit with your diversification focus? Would you rather build or
buy?
As you
point out, we believe that we have a significant amount of expertise in
evaluating and managing portfolios of hedge funds and other alternative assets.
Our focus has been:
·
incorporating hedge funds and other alternative strategies as part of
broader investment portfolios that we manage for existing clients
·
managing diversified alternative portfolios as part of registered mutual
fund and ETF portfolios as well as on our Morningstar Investment Services
advisory platform; and
·
providing investment consulting services to fund-of-hedge-funds
platforms and managers.
Weve also
gained additional hedge fund investment expertise through the Intech
acquisition in Australia (which currently manages a fund-of-hedge-funds
portfolio for existing clients) and the Seeds acquisition in France, where the majority
of Seeds revenue is derived from hedge fund-related consulting services.
20.
Can you
talk a bit about how the investment consulting business has recovered since a
few large client losses during the downturn? Are you noticing an up-tick in RFP
activity? How has the timeline of the RFP process been impacted, has it been
extended given everything that the world has been through? What have you
noticed about the competitive landscape in this business in the past few years?
8
Yes, weve
noticed an increase in RFP activity and have seen more deals beginning to flow
through the pipeline for Investment Consulting. Weve seen many financial
services companies beginning to engage in sales discussions again; however, the
process has typically moved more slowly than in the past because of lingering
budget concerns and other after-effects of the financial crisis that started in
2008.
One change
weve seen in the competitive landscape is that asset management firms have
been positioning themselves more as comprehensive investment solution
providers. Increasingly, these firms are viewing asset allocation and portfolio
construction as important capabilities to nurture internally. However, we
believe we still offer a competitive advantage, particularly when we deliver
products and solutions that leverage our core strengths in research,
technology, and design. Were continuing to work on leveraging these core
capabilities globally, as well.
21.
Can you
talk a bit more about the distribution of the Retirement products? How
many plan providers/plan sponsors do you currently serve? What is the
global geographic distribution? What is the process typically like in
terms convincing new providers to place your product on their platform? Is
this different at all at Morningstar versus Ibbotson?
We
currently serve approximately 145,000 retirement plan sponsors through 23 plan
providers, with the majority of this business in the United States.
We
currently have relationships with approximately half of the major plan
providers. We work closely with these plan providers to increase our presence
on their platforms. Weve also had some success working directly with
retirement plan sponsors.
We
currently offer two retirement solutions: Morningstar Retirement Manager and
Advice by Ibbotson. The process for selling these two solutions is similar.
22.
Can you
update us on the number of relationships with plan providers, assets at those
plan providers, and other plan sponsors that you have relationships for the
Retirement Manager product? What proportion of assets and people roughly at
these plan providers does your product touch relative to the aggregate pie at
these organizations/people? Has this proportion increased over
time? How do you sign up additional plan sponsors/plan providers/plan
administrators to your product, is it direct sales and just blocking and
tackling following that?
As
mentioned above, we currently have relationships with 145,000 plan sponsors
through 23 plan providers through both Morningstar Retirement Manager and
Advice by Ibbotson. The table below shows our assets under management in
managed retirement accounts.
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As of September 30
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Assets under management in managed retirement accounts ($ billions)
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2010
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2009
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Advice
by Ibbotson
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$
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16.0
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$
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13.2
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Morningstar
Retirement Manager
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1.8
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1.4
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Total
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$
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17.8
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$
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14.6
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Of all the
plan participants who are eligible for our retirement advice services, a
relatively small percentage (less than 10%) has enrolled. For example, total
assets in Advice by Ibbotson represent approximately 9% of eligible plan
assets. These enrollment numbers have increased slightly over time.
To
increase our reach in this market, we actively promote our capabilities to
retirement plan providers, sponsors, and participants. Weve also implemented
several technology and operational initiatives that improve efficiency and
facilitate enrollment. For example, we
9
introduced
a new delivery and reporting tool for plan sponsors and a new barcode
enrollment form that simplifies the enrollment process. Weve also rolled out
new products and solutions, such as target-date and lifetime advice portfolios.
International
Operations
23.
Do you
have a targeted proportion of revenue that eventually would come from
international operations? What are your current operations as well as eventual
plans in the Latin American region?
Because
non-U.S. markets account for more than half of the worlds market
capitalization, we believe that our international revenue has the potential to
approach that percentage over time. We currently have operations in 26
countries, and international revenue made up 29% of total revenue for the most recent
quarter. We recently established operations in Brazil, Chile, and Mexico and
plan to expand our sales efforts in the region over the next several years.
24.
What is
the rationale for holding only minority interests in Morningstar Japan,
Denmark, and Sweden and not owning those subsidiaries outright?
We
recently acquired an additional 75% interest in Morningstar Denmark, increasing
our ownership to 100%. So our only two minority ownership interests are
Morningstar Japan KK, which we established in 1998, and Morningstar Sweden,
which we established in 2001. We began these operations as minority interests
because at the time, it was the most expedient way for us to gain access to
these markets. We now have more established operations outside the United
States and generally prefer to be a majority or full owner of any new
operations that we establish.
25.
Can you
talk a bit about how the more European private banking model versus the North
American brokerage model has determined/impacted your strategy or product sets
in Advisors distribution channels outside of the U.S.? Or has the robustness of
the product, particularly with regards to a diversification focus through funds
rather than singular stocks generally been of enough usefulness to not matter
in terms of your growth? What do EMEA or Asian clients in this business usually
ask differently of the more wirehouse-centric, and commission-based from a
revenue perspective, North American advisor?
The European private banking model
has not greatly altered the product strategy for our Advisor tools outside the
United States. Our strategy is based on selling robust advisor-focused tools,
including holdings-based portfolio analysis and high-quality technology
platforms, to make them a compelling option for firms looking for best-in-class
fund solutions.
That said, weve had more success
in those European markets that are more similar to the United States: i.e.,
where there is open architecture and a greater number of independent advisors
in the distribution channels. We see less success in markets without these
attributes because we dont have as many opportunities to add value to
institutions and their captive or tied advisors who recommend investments from
limited, proprietary product lineups.
In Asia, weve experienced demand
for advisor tools that provide a well-defined process for identifying the end
investors risk tolerance, asset allocation and investment selection. This
demand is similar to what weve historically seen with North American wirehouses
and brokerage firms, although were also looking at ways to tailor our tools to
meet the more specialized client needs in Aisa.
10
Programming
and Technology Team
26.
What is
the size of your programming/technology team now compared to your IPO in terms
of headcount? You recently identified this area in terms of product
development as an area of reinvestment. Can you provide some more color
what areas/geographies you are adding people and what specifically you have
planned?
We have
been heavily investing in our technology and development team over the past
several years. We now have approximate 820 programmers and other technology
professionals on staff, compared with about 230 when we went public in 2005.
About half of these employees are in our offshore development centers in China
and India, one-third is in the United States, and the remainder is in other
global operations, such as Europe and Australia.
Sales
Organization
27.
How is
your sales force compensated? Does it vary by product? I noticed
you changed your income statement convention for expensing sales commissions,
now expensing the entire sales commission up front why was this
done? Are all staff other than salespeople generally on a salary/bonus
structure and salespeople on a commission type of matrix? Do you feel you
are under punching so to speak with your current sales and client service
organization?
Our sales
force generally earns a smaller base salary plus commission, with the
commission plan varying by product. For our U.S.-based National Sales Group, we
recently changed to a new commission plan based on the sales reps annualized
book of business rather than upon contract renewal. Because of the structure of
this plan, we believe that recording the entire commission expense in the
quarter versus over the term of the client contract is the appropriate
accounting treatment.
Were
always looking for ways to enhance sales force productivity, but the change in
the commission plan wasnt really driven by a desire to increase production. We
wanted to incentivize the sales team to focus on adding value for all of our
clients and generating consistent book-of-business growth. The previous
structure had some drawbacks because payouts could be heavily influenced by
renewals on large contracts, which tend to happen less frequently.
The
majority of our non-commissioned employees are paid salaries and are also
eligible for bonus payments.
Business
Model/Payment Structure
28.
All subscription/licensed
products and services are a pay cash up front type of structure?
Yes, we
generally invoice clients and collect cash in advance of providing services or
fulfilling subscriptions, particularly for products and services in our
Investment Information segment. In the Investment Management business, its
more common for services to be billed in arrears.
Dodd-Frank
and Other Regulation
29.
What
opportunities and/or difficulties does the Dodd-Frank bill create? What
about other regulation around the globe?
The
Dodd-Frank Act is enormously complex, and our analysis will be ongoing. In
addition, many portions of the bill have yet to be addressed through rulemaking
and other regulatory action, giving the regulators significant discretion in many
areas. At this point, we believe the portion of the Act most relevant to
Morningstar is Title IX (Investor Protections and Improvements to the
11
Regulation
of Securities), which contains broad changes to the regulatory framework for
credit rating agencies as well as a number of corporate governance and
disclosure changes applicable to publicly traded companies. Were continuing to
evaluate the potential impact of the Dodd-Frank Act on Realpoint, a Nationally
Recognized Statistical Rating Organization we acquired in May 2010.
As far as
other regulation around the world, we believe some of the recent regulations in
Europe and the United Kingdom may provide us with opportunities. For example,
the Retail Distribution Review that becomes effective at the end of 2012 will
require advisors to give clients a choice of all investment vehicles (including
funds, ETFs, and structured products) and demonstrate that they considered the
entire universe without bias. We also see a potential business opportunity
associated with UCITS IV, which will require fund companies to create a
standard simplified prospectus for funds sold across Europe.
Decentralized
Structure
30.
My
understanding is your segment reporting reflected your decentralized approach
to managing the distribution channels, leveraging the core technology/data
infrastructure. How has this changed since last years
re-segmentation? Can you provide some color on the corporate hierarchy of
the Investment Information segment? In this vein, as the company has
expanded internationally how are these businesses run are they autonomous,
semi-autonomous, or otherwise? Any color would be helpful how the
information chain from the executive suite reaches the various business units
would be helpful.
Our
decentralized approach to the business hasnt really changed. We tend to prefer
a more decentralized approach because we believe it helps increase speed and
accountability. Beginning in 2009, we organized our operations according to
product lines and growth strategies rather than audience segments and have two
operating segments: Investment Information and Investment Management.
Previously, we organized our operations based on three audience segments:
Individual, Advisor, and Institutional. Weve continued to emphasize a
decentralized approach to running the business under both of these segment
structures.
Within the
Investment Information segment, we have three divisions: Data (headed by Liz
Kirscher), Software (headed by Chris Boruff), and Investment Research (headed
by Cathy Odelbo and Don Phillips). Each division encompasses several business
units that are led by separate managers. For example, within the Software
division, we have managers focused on specific product lines such as
institutional software, advisor software, individual software, custom
solutions, and LIM (Logical Information Machines), which we acquired in 2009.
Each business unit manager works closely with the business division president
and is accountable for the profit-and-loss performance of his or her area.
For the
sake of efficiency, weve centralized some of our corporate functions, and we
have a centralized programming team that develops key software features that we
can incorporate in multiple products and services.
In the
past, our international structure was mainly based on geography, and we
primarily defined accountability at the country level. Now, our business
divisions and business units are becoming more global in nature, and we expect
this to be a major area of focus in 2011.
Regarding
how the information chain flows from the executive suite (which is easier in
our case because we have an open-office plan instead of private suites) to the
business units, we maintain constant, informal communication with all of the
business division presidents. The division presidents report to Joe Mansueto,
our chairman and CEO. In addition to many informal meetings
12
and
communications, we conduct business reviews with each major area on a quarterly
basis. We also hold an annual management retreat where we bring together our
business leaders to talk about our priorities for the upcoming year.
Seasonality
31.
Remind
me, there does seem to be a modest amount of seasonality in your business in 2Q
due to investment conferences?
Yes, we
typically have some seasonality in our Investment Information segment because
we hold our annual Morningstar Investment Conference during the second quarter.
Business
Environment
32.
Can you
speak to how client budget conditions have evolved over the course of the
year? Any color particularly in terms of your institutional clients and
which types of clients may be loosening the purse strings?
Weve
generally seen improving business conditions throughout the course of 2010.
While some institutional clients have remained cautious, weve generally seen
clients becoming more receptive to new projects and sales discussions.
Outsourcing and retirement clients have been two bright spots, and insurance,
asset management, and broker-dealer firms have also shown interest in new deals
.
Retention
and Renewal Rates
33.
My
understanding is about 3-5% of your walk-in revenue cancels each year,
implying a mid-90s retention rate, so to speak? What is the primary
driver of this M&A, price concessions, general turnover, product
dissatisfaction, and/or other reasons for cancellations? How was this
figure impacted in 2008 relative to say 2005-2006? Where does it roughly
stand for 2010? How does this differ across the products so say licensed
data, MORN Direct, Morningstar.com, Principia, Advisors Workstation, and
Retirement Manager?
We use two
different methods for calculating retention. For subscription-based products
(such as newsletters, Morningstar.com Premium Membership, and Principia
software), we track the number of subscriptions retained during the year. For
products sold through contracts and licenses, we compare the dollar value of
renewals compared with the value of contracts up for renewal during the period.
For
subscription-based products, our retention rate has generally been in the range
of 60% to 65%, with higher retention rates for Principia and lower rates for
retail products such as newsletters and Premium membership subscriptions. The
table below shows retention rates over the past several years:
2005
|
|
2006
|
|
2007
|
|
2008
|
|
2009
|
|
60-65%
|
|
60-65%
|
|
65-70%
|
|
60-65%
|
|
55-60%
|
|
Retention
rates were lower in 2009 because fewer subscribers to Principia and
Morningstar.com continued their subscriptions in the uncertain economic
environment. With Morningstar.com, we also had fewer new subscribers coming in
to offset subscriptions that expired.
13
Retention
rates have improved slightly in 2010, reflecting higher retention rates for
Principia and Premium memberships.
For
contract-based products and services, our renewal rate ranged between 95% and
105% from 2005 through 2007, but began declining with the financial crisis in
2008, as shown in the table below:
2005
|
|
2006
|
|
2007
|
|
2008
|
|
2009
|
|
100-105%
|
|
95-100%
|
|
95-100%
|
|
90-95%
|
|
80-85%
|
|
We
estimate that our 2008 renewal rate was on the low end of the range between 90%
and 95% and down about 6 percentage points from 2007. The decline in renewal
rates in 2008 was largely driven by lower assets in Investment Consulting.
Assets were down partly because of the market decline. In addition, we werent
able to reach agreement on renewal terms for one of our larger client
contracts, which expired in the second quarter. We also experienced some
pressure on renewal rates for other products, such as Morningstar Advisor
Workstation, later in the year.
In 2009,
we estimate that our weighted average renewal rate was on the low end of the
range between 80% and 85% and down about 9.5 percentage points from our renewal
rate in 2008. The decline in renewal rates in 2009 was largely driven by the
end of the Global Analyst Research Settlement period. Excluding this factor,
the 2009 renewal rate declined about 3 percentage points from 2008. This
decline reflects lower renewal rates for several product lines, including
Investment Consulting, institutional software, and advisor software. Many of
our clients were cutting budgets, reducing staff, and experiencing the effects
of industry consolidation during 2009.
So far in
2010, renewal rates have generally improved, averaging 90% or better for most
products.
Insider
Ownership
34.
Can you
remind us of Mr. Mansuetos divestiture schedule/plan?
Previously,
Joe has had a 10b5-1 plan in place that provided for selling approximately 1%
of his shares per quarter, or 4% per year. However, Joe terminated this plan
during the third quarter of 2010 and has not replaced it.
Balance
Sheet
35.
Can you
provide color on what types of corporate bonds are in your securities
portfolio? What is the average duration and/or maturity of the aggregate
securities portfolio?
Although
our securities portfolio focuses on municipals with high underlying credit
ratings, you are correct that it also contains a number of corporate issues.
Our corporate holdings carry AA or higher ratings. Both the average maturity
and average duration of the overall portfolio are approximately one year.
Acquisitions
36.
Has the
deal flow pipeline remained robust?
Its our
policy not to comment on potential acquisitions.
14
Dividend/Share
Repurchase Programs
37.
Do you
have an outstanding share repurchase authorization and, if so, can you remind
us what it is?
Yes, we
recently announced that our board of directors has authorized a $100 million
share repurchase program.
38.
Assuming
you determine there may be a lack of internal and external growth opportunities
to expend your cash, would your preference be to establish a dividend,
repurchase stock or some combination of the two?
We
recently announced that our board of directors has authorized a regular
quarterly dividend of 5 cents per share beginning with the first quarter of
2011, as well as a $100 million share repurchase program. The first quarterly
dividend will be payable on January 14, 2011 to shareholders of record on December 31,
2010.
39.
Please
give us more details surrounding the dividend that Morningstar will be paying
to shareholders. Is this a sign that management cannot find better
opportunities by reinvesting that cash into Morningstars existing businesses
or acquiring new ones?
Weve
consistently generated healthy free cash flow, even after using cash for
acquisitions and continuing to reinvest in our existing business. Even after
initiating a small dividend payment, we believe we have the resources available
to continue investing both internally and externally (if and when attractive
acquisition opportunities arise).
40.
As for
the repurchase program, do you believe that Morningstar stock is selling well
below intrinsic value and can you quantify the gain that you expect in that
value from the repurchase program?
Its our policy not to comment
about our stock price or provide estimates of Morningstars intrinsic value.
15
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.
|
MORNINGSTAR, INC.
|
|
|
|
|
|
|
Date: November 5, 2010
|
By:
|
/s/ Scott Cooley
|
|
Name:
|
Scott Cooley
|
|
Title:
|
Chief Financial Officer
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