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Margaret Kirch Cohenmargaret.cohen@morningstar.com
Morningstar, Inc. Reports First Quarter 2006 Financial Results
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CHICAGO, May 4, 2006 — Morningstar, Inc. (NASDAQ: MORN), a leading provider of independent investment research, today announced its first quarter 2006 financial results. The company reported consolidated revenue of $70.1 million in the first quarter of 2006, a 32% increase from revenue of $53.2 million in the first quarter of 2005. Revenue for the first quarter included $4.4 million from Ibbotson Associates, Inc. Morningstar acquired Ibbotson, a leading provider of asset allocation research and services, on March 1, 2006, and began including Ibbotson in its financial results on that date. Morningstar’s net income was $13.4 million in the first quarter of 2006, or 29 cents per diluted share, compared with $4.0 million, or 9 cents per diluted share, in the first quarter of 2005.

Morningstar purchased Ibbotson for $83.0 million in cash plus $3.4 million for working capital and other items, subject to post-closing adjustments. The acquisition contributed first quarter revenue of $0.5 million in Morningstar’s Individual segment, $1.5 million in the Advisor segment, and $2.4 million in the Institutional segment. Historically, Ibbotson’s revenue has been higher in March because of the seasonal nature of its books business, including the Stocks, Bonds, Bills, and Inflation Yearbook, which is published annually in March. Morningstar includes these annual reference guides in its Individual segment.

 
Joe Mansueto, chairman and chief executive officer of Morningstar, said, “We’re well on our way to integrating Ibbotson into our operations. Even though this quarter only includes one month of Ibbotson’s results, its products are already making meaningful contributions to our business, especially in the Advisor and Institutional segments. We’re particularly excited about Ibbotson’s funds of funds consulting, managed retirement accounts, and institutional software services.

“Our underlying business also continued to generate strong organic growth, with revenue increasing 24% in the first quarter, excluding Ibbotson and foreign currency translations. Nearly all of our core products contributed to revenue growth, with Morningstar Advisor Workstation Enterprise Edition and Investment Consulting posting the largest gains,” Mansueto added. “Also during the quarter we launched the Morningstar Dividend Leaders Index, which First Trust Advisors is licensing for use in a new exchange-traded fund, and we introduced a star rating for exchange-traded funds.”

Key Business Drivers
Revenue:  Revenue in the Individual segment was $19.1 million in the first quarter of 2006, a 23% increase from $15.5 million in the first quarter of 2005.  Revenue in the Advisor segment was $21.8 million in the first quarter of 2006, a 32% increase compared with $16.5 million in the same period in 2005. Revenue in the Institutional segment was $30.6 million in the first quarter of 2006, a 37% increase from $22.3 million in the first quarter of 2005.

Revenue from international operations was $8.4 million in the first quarter of 2006, a 21% increase from $7.0 million in the same period a year ago. International revenue included $0.2 million from Ibbotson. Foreign currency translations had a negative impact of $0.2 million on international revenue. Excluding the impact of foreign currency translations and the Ibbotson acquisition, consolidated revenue increased approximately 24% and international revenue increased approximately 21%, respectively, compared with the prior-year period.

Revenue Composition:  Morningstar defines “walk-in” revenue as revenue it expects to recognize during the year from subscriptions and license agreements in place as of Jan. 1 of each year, adjusted for cancellations, currency translations, and other routine adjustments during the year. During the first quarter of 2006, the company closed renewals and brought in new business that will contribute an estimated $52.2 million to 2006 revenue, absent cancellations. Morningstar estimates that 2006 walk-in revenue plus the full-year impact of new and renewal business closed during the first quarter, absent additional cancellations, will total $189.2 million. Revenue from Ibbotson has not yet been incorporated into new, renewal, or walk-in revenue.

Operating Income:  Consolidated operating income was $19.2 million in the first quarter of 2006, an increase of $12.3 million, or 179%, compared with $6.9 million in the same period a year ago. Lower stock-based compensation expense had a significant impact on the increase in operating income. Excluding stock-based compensation expense, operating income in the first quarter of 2006 was $21.1 million, an increase of $9.3 million, or 80%, compared with $11.8 million in the first quarter of 2005. This increase reflects the underlying strength of Morningstar’s business, which was driven by revenue growth that outpaced growth in operating expense across all business segments. The Ibbotson acquisition also contributed to operating income growth.

The company’s operating margin was 27.4% in the first quarter of 2006, compared with 12.9% in the same period in 2005. The increase in operating margin partly reflects the decline in stock-based compensation expense compared with the first quarter of 2005. Excluding stock-based compensation expense, the company’s operating margin was 30.2% in the first quarter of 2006, compared with 22.1% in the prior-year period.

Operating income and operating margin before stock-based compensation expense are measures that are not calculated in accordance with U.S. generally accepted accounting principles (GAAP). A reconciliation to operating income and operating margin is included in the accompanying financial tables.

Stock-based Compensation Expense:  Stock-based compensation expense decreased $3.0 million in the first quarter of 2006 to $1.9 million, compared with $4.9 million in the first quarter of 2005. The lower level of stock-based compensation expense mainly reflects the fact that after the company’s initial public offering in May 2005, Morningstar no longer records stock-based compensation expense under the liability method. In the first quarter of 2005, the company recorded $2.8 million of stock-based compensation expense under the liability method, which did not recur in 2006.

Free Cash Flow:  Morningstar generated free cash flow of $9.1 million in the first quarter of 2006, reflecting cash provided by operating activities of $9.9 million and capital expenditures of approximately $0.8 million. Free cash flow increased by $12.4 million, primarily because of an increase in net income adjusted for non-cash items. Free cash flow is a non-GAAP measure that is reconciled to cash provided by or used for operating activities in the accompanying financial tables. Morningstar defines free cash flow as cash provided by or used for operating activities less capital expenditures.

As of March 31, 2006, Morningstar had cash, cash equivalents, and investments of $82.9 million, compared with $153.2 million as of Dec. 31, 2005. The decrease reflects cash used for the acquisition of Ibbotson and annual bonus payments.

Business Segment Performance
In the first quarter of 2006, Morningstar changed its segment reporting by allocating stock-based compensation expense to each of its three business segments; before 2006, stock-based compensation expense was recorded as a corporate item. This change gives management a more complete picture of the profitability of each business segment after fully allocating stock-based compensation expense. Morningstar has reclassified its segment results for 2005 to reflect this change.

Operating income and operating margin growth rates for all segments were more favorable year over year because higher stock-based compensation expense in the first quarter of 2005 had a larger negative impact on margins in that period.

Individual Segment:  The largest product in this segment based on revenue is the company’s U.S.-based Web site for individual investors, Morningstar.com®. The Individual segment also includes Morningstar® Equity Research and several print and online publications.

  •  Revenue was $19.1 million in the first quarter of 2006, a 23% increase from $15.5 million in the first quarter of 2005. Morningstar.com Premium Membership and Equity Research drove most of the
    revenue increase. The first quarter tends to show more sales activity for Premium Membership on Morningstar.com and other products such as Morningstar® Stocks 500 TM and Morningstar®
    Funds 500 TM, which are reference guides that the company publishes once a year. In addition, first quarter revenue for this segment included revenue from Ibbotson’s Stocks, Bonds, Bills, and
    Inflation Yearbook, which is published in March of each year.
  • Operating income was $5.6 million in the first quarter of 2006, a 129% increase from $2.4 million in the prior-year period. Operating income benefited from a $1.0 million decrease in stock-based compensation expense.
  • Operating margin was 29.1% in the first quarter of 2006, compared with 15.6% in the first quarter of 2005. Approximately 7 percentage points of the increase came from lower stock-based compensation expense as a percentage of revenue.

Advisor Segment:  The largest products in this segment based on revenue are Morningstar® Advisor WorkstationSM, Morningstar® Principia®, and Morningstar® Managed Portfolios(SM).

  • Revenue was $21.8 million in the first quarter of 2006, a 32% increase from $16.5 million in the same period in 2005. Advisor Workstation Enterprise Edition contributed the majority of the revenue increase. The Advisor segment also included March revenue from Ibbotson’s Financial Communications business. 
  • Operating income was $6.1 million in the first quarter of 2006, an increase of 135% compared with $2.6 million in the first quarter of 2005. Operating income benefited from a $0.9 million decrease in stock-based compensation expense. 
  • Operating margin was 28.0% in the first quarter of 2006, compared with 15.7% in the first quarter of 2005. Approximately 6 percentage points of the increase came from lower stock-based compensation expense as a percentage of revenue.

Institutional Segment:  The key products and services in this segment based on revenue are Licensed DataSM, Investment Consulting, retirement advice (including Advice by Ibbotson® and Morningstar® Retirement ManagerSM ), Licensed Tools and Content, Morningstar DirectSM,  and EnCorr®.

  • Revenue was $30.6 million in the first quarter of 2006, a 37% increase from $22.3 million in the first quarter of 2005. Investment Consulting (including March revenue from Ibbotson), Licensed Data, and Morningstar Direct drove most of the revenue increase.
  • Operating income was $8.7 million in the first quarter of 2006, an increase of 181% from $3.1 million in the same period in 2005. Operating income benefited from a $1.1 million decrease in stock-based compensation expense.
  • Operating margin was 28.4% in the first quarter of 2006, compared with 13.9% in the prior-year period. Approximately 6 percentage points of the increase came from lower stock-based compensation expense as a percentage of revenue.

About Morningstar, Inc.
Morningstar, Inc. is a leading provider of independent investment research in the United States and in major international markets. The company offers an extensive line of Internet, software, and print-based products and services for individuals, financial advisors, and institutions. Morningstar provides data on more than 145,000 investment offerings, including stocks, mutual funds, and similar vehicles. The company has operations in 12 countries and minority ownership positions in companies based in four other countries.

Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995
This press release contains forward-looking statements. These statements relate to future events or to future financial performance and involve known and unknown risks, uncertainties, and other factors that may cause our actual results, levels of activity, performance, or achievements to be materially different from any future results, levels of activity, performance, or achievements expressed or implied by these forward-looking statements.  In some cases, you can identify forward-looking statements by the use of words such as “may,” “could,” “expect,” “intend,” “plan,” “seek,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” or “continue” or the negative of these terms or other comparable terminology.  You should not place undue reliance on forward-looking statements because they involve known and unknown risks, uncertainties, and other factors that are, in some cases, beyond our control and that could materially affect actual results, levels of activity, performance, or achievements.
 
Other factors that could materially affect actual results, levels of activity, performance, or achievements can be found in Morningstar’s filings with the Securities and Exchange Commission, including Morningstar’s Annual Report on Form 10-K for the year ended Dec. 31, 2005. If any of these risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may vary significantly from what we projected.  Any forward-looking statement you read in this press release reflects our current views with respect to future events and is subject to these and other risks, uncertainties, and assumptions relating to our operations, results of operations, growth strategy, and liquidity. We assume no obligation to publicly update or revise these forward-looking statements for any reason, whether as a result of new information, future events, or otherwise.

Non-GAAP Financial Measures
To supplement Morningstar’s consolidated financial statements presented in accordance with GAAP, Morningstar uses the following measures defined as non-GAAP by the Securities and Exchange Commission:  free cash flow, operating income before stock-based compensation expense, and operating margin before stock-based compensation expense. Morningstar presents free cash flow solely as supplemental disclosure to help its investors better understand how much cash is available after Morningstar spends money to operate its business. Morningstar uses free cash flow to evaluate the performance of its business. Free cash flow should not be considered an alternative to any measure of performance as promulgated under GAAP (such as cash provided by (used for) operating, investing, and financing activities), nor should this data be considered an indicator of Morningstar’s overall financial performance or liquidity. Also, the free cash flow definition used by Morningstar may not be comparable to similarly titled measures reported by other companies. For more information on free cash flow, please see the reconciliation from cash provided by operating activities to free cash flow included in the accompanying financial tables. 

Morningstar presents operating income before stock-based compensation expense and operating margin before stock-based compensation expense solely as supplemental disclosure to help its investors better understand the performance of its business, to enhance comparison of Morningstar’s performance from period to period, and to allow better comparison of Morningstar’s performance with that of its competitors. Morningstar expects stock-based compensation expense to be a recurring cost. Morningstar uses operating income before stock-based compensation expense and operating margin before stock-based compensation expense to evaluate the performance of its business. Operating income before stock-based compensation expense and operating margin before stock-based compensation expense should not be considered alternatives to any measure of performance as promulgated under GAAP (such as operating income or operating margin), nor should this data be considered an indicator of Morningstar’s overall financial performance or liquidity. Also, the calculations of operating income before stock-based compensation expense and operating margin before stock-based compensation expense used by Morningstar may not be comparable to similarly titled measures reported by other companies. For more information on operating income before stock-based compensation expense and operating margin before stock-based compensation expense, please see the reconciliations from operating income to operating income before stock-based compensation expense and from operating margin to operating margin before stock-based compensation expense included in the accompanying financial tables. 

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©2006 Morningstar Inc.  All rights reserved.

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