Morningstar, Inc. Reports Third-Quarter 2014 Financial Results

Morningstar, Inc. (NASDAQ: MORN), a leading provider of independent investment research, today announced its third-quarter 2014 financial results. The company reported consolidated revenue of $193.1 million, an 11.3% increase from $173.5 million in the third quarter of 2013. Consolidated operating income was $45.3 million, an increase of 1.5% compared with $44.6 million in the same period a year ago. Net income was $30.2 million, or 67 cents per diluted share, compared with $31.5 million, or 68 cents per diluted share, in the third quarter of 2013.

Excluding acquisitions, divestitures, and the effect of foreign currency translations, revenue rose 9.3% in the third quarter of 2014. Revenue excluding acquisitions, divestitures, and foreign currency translations (organic revenue) is a non-GAAP measure. The accompanying financial tables contain a reconciliation to consolidated revenue.

Joe Mansueto, chairman and chief executive officer of Morningstar, said, “We had a good quarter. Organic revenue rose 9.3%, led by strong results from Morningstar Direct and Morningstar Credit Ratings. Our retirement business is growing nicely and reached a milestone—we now have more than 1 million managed retirement accounts in the United States.”

He added, “During the quarter, we published several signature thought leadership reports, including our annual target-date industry research, and introduced a classification system to help investors identify, compare, and analyze strategic beta exchange-traded products, a new and growing breed of investment vehicles.”

Financial Highlights

Revenue and Key Operating Metrics 
• Investment information revenue was $152.3 million, an 11.0% increase from $137.2 million in the third quarter of 2013. Morningstar DirectSM and Morningstar Credit Ratings (the company’s structured credit research and ratings business) were the main contributors to revenue growth. Morningstar® Advisor WorkstationSM (including Morningstar OfficeSM) was also a positive contributor to revenue growth, which was offset by lower revenue for Morningstar® Principia®. The company is in the process of migrating clients from Principia to Morningstar Advisor Workstation and other Morningstar products. 
• Investment management revenue was $40.9 million, a 12.7% increase from $36.3 million in the third quarter of 2013, driven by strong results for Morningstar® Managed PortfoliosSM and Retirement Solutions. Slightly lower revenue for Investment Advisory services partially offset the increase. 
• Operating margin was 23.4% in the third quarter of 2014, down from 25.7% in the same period in 2013. Higher compensation expense, including salaries for new hires and increased sales commissions, as well as additional operating expense from recent acquisitions, were the primary drivers of the margin decline.

Cash Flow and Balance Sheet 
• Consolidated free cash flow was negative $3.4 million in the third quarter of 2014, reflecting cash provided by operating activities of $8.6 million less $12.0 million of cash used for capital expenditures. Free cash flow was down from $38.0 million in the third quarter of 2013 largely because of the $61.0 million payment for the previously announced litigation settlement with Business Logic. Free cash flow is a non-GAAP measure; the accompanying financial tables contain a reconciliation to cash provided by operating activities. Morningstar defines free cash flow as cash provided by or used for operating activities less capital expenditures. 
• As of Sept. 30, 2014, cash, cash equivalents, and investments totaled $227.8 million, compared with $298.6 million as of Dec. 31, 2013. Morningstar had $30.0 million of short-term debt as of Sept. 30, 2014. 
• In the third quarter of 2014, Morningstar repurchased approximately 134,000 shares for $9.1 million. Of the $700 million authorized under its share repurchase program, Morningstar had purchased a total of 7.7 million shares for $495.6 million as of Sept. 30, 2014.
• The company expects to pay approximately $7.6 million for its regular quarterly dividend on Oct. 31, 2014.

Comparability of Year-Over-Year Results 
Certain items affected the comparability of the company’s 2014 results versus the same periods in 2013: 
• The company’s third-quarter results included $2.8 million in revenue and approximately $5.5 million of incremental operating expense from acquisitions. 
• During the third quarter of 2014, commission expense rose $1.8 million compared with the prior-year period, mainly because of a change to the company’s sales commission structure that requires a different accounting treatment. Morningstar now expenses sales commissions as incurred instead of amortizing them over the term of the underlying contracts. 
• During the second quarter of 2014, Morningstar recorded a non-recurring expense of $61.0 million—approximately $38.2 million after taxes, or 85 cents per share—in connection with the Business Logic litigation settlement, which is included in the company’s results for the nine months ended Sept. 30, 2014. 

Operating Highlights
• Licenses for Morningstar Direct rose 17.0% to 9,648. 
• Assets under management and advisement for Morningstar Managed Portfolios were approximately $8.8 billion as of Sept. 30, 2014, compared with $6.6 billion as of Sept. 30, 2013. Assets under management and advisement for Retirement Solutions were approximately $76.7 billion as of Sept. 30, 2014, versus $59.5 billion as of Sept. 30, 2013. Both product lines benefited from asset inflows and positive market performance. 
• Investment Advisory assets under advisement as of Sept. 30, 2014 were $25.7 billion lower versus the same date in 2013, reflecting the ongoing effect of clients moving to in-house management for fund-of-funds portfolios in the variable annuity industry. 
• Morningstar had approximately 3,800 employees worldwide as of Sept. 30, 2014, compared with 3,490 as of Sept. 30, 2013, reflecting the addition of product and technology roles in the United States, data analysts in India, and the ByAllAccounts and HelloWallet acquisitions.

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