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Margaret Kirch Cohenmargaret.cohen@morningstar.com
Morningstar, Inc. Reports Second Quarter 2006 Financial Results
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CHICAGO, Aug. 3, 2006 — Morningstar, Inc. (NASDAQ: MORN), a leading provider of independent investment research, today announced its second quarter 2006 financial results. The company reported consolidated revenue of $76.3 million in the second quarter of 2006, a 36% increase from revenue of $56.2 million in the second quarter of 2005. Revenue for the second quarter included $6.8 million from Ibbotson Associates, Inc., a leading provider of asset allocation research and services, which Morningstar acquired on March 1, 2006. Consolidated operating income was $17.5 million in the second quarter of 2006, an increase of $4.4 million, or 33%, compared with $13.1 million in the same period a year ago. Morningstar’s net income was $11.2 million in the second quarter of 2006, or 24 cents per diluted share, compared with $9.5 million, or 22 cents per diluted share, in the second quarter of 2005.

In the first six months of 2006, revenue increased $36.9 million, or 34%, to $146.3 million, compared with $109.4 million in the same period a year ago. Revenue for the first half of the year included $11.2 million from Ibbotson. Consolidated operating income increased 83% to $36.7 million in the first six months of 2006, compared with $20.0 million in the first six months of 2005. Net income was $24.6 million, or 53 cents per diluted share, in the first half of 2006, compared with $13.5 million, or 31 cents per diluted share, in the first six months of 2005.

“We generated strong organic revenue growth of 23% in the second quarter, driven by several key products—Investment Consulting, Advisor Workstation, Licensed Data, and Morningstar.com.  We also benefited from incremental revenue from the Ibbotson acquisition, primarily led by Investment Consulting and EnCorr,” said Joe Mansueto, chairman and chief executive officer of Morningstar.  “We’ve retained all six contracts for independent equity research associated with the Global Analyst Research Settlement. Most of these contracts, which typically come up for renewal in the second quarter, cover the third year of the five-year settlement period.”
 
Mansueto added, “In July, we acquired Aspect Huntley, a leading provider of equity research and information in Australia, and earlier this week we acquired the database division of InvestorForce, which will add critical mass to our institutional hedge fund and separate account coverage as well as to our client base. Both acquisitions are aligned with our growth strategies and will significantly enhance our offerings to individual investors, advisors, and institutions.”

Key Business Drivers
Revenue:  Revenue in the Individual segment was $19.4 million in the second quarter of 2006, a 24% increase from $15.6 million in the second quarter of 2005.  Revenue in the Advisor segment was $24.3 million in the second quarter of 2006, a 30% increase compared with $18.8 million in the same period in 2005. Revenue in the Institutional segment was $34.3 million in the second quarter of 2006, a 49% increase from $23.0 million in the second quarter of 2005.

The Ibbotson acquisition contributed second-quarter revenue of $0.4 million in Morningstar’s Individual segment, $1.5 million in the Advisor segment, and $4.9 million in the Institutional segment.

Revenue from international operations was $9.5 million in the second quarter of 2006, a 34% increase from $7.1 million in the same period a year ago. International revenue included $0.5 million from Ibbotson. Foreign currency translations had a positive impact of $0.2 million on international revenue. Excluding the impact of foreign currency translations and the Ibbotson acquisition, consolidated revenue and international revenue both increased approximately 23% compared with the prior-year period. Revenue growth excluding Ibbotson and foreign currency is a non-GAAP measure that is reconciled to consolidated and international revenue growth rates in the accompanying financial tables.

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 second quarter of 2006, the company closed renewals and brought in new business that will contribute an estimated $99.0 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 half of 2006, absent additional cancellations, will total $230.6 million. During the quarter, the company reclassified a portion of its revenue composition, reducing 2006 walk-in revenue by $5.0 million, $3.2 million of which is now classified as renewal revenue. Revenue from Ibbotson has not yet been incorporated into new, renewal, or walk-in revenue. 

Operating Income:  Consolidated operating income was $17.5 million in the second quarter of 2006, a 33% increase from the second quarter of 2005. Operating expense rose $15.7 million, or 36%, in the second quarter of 2006, primarily because of a $9.1 million increase in compensation-related expense. This includes a $4.3 million increase in accrued incentive compensation, which reflects the second-quarter impact of updated internal estimates for full-year performance versus 2005; an adjustment to bring year-to-date bonus expense in line with these estimates; and incremental bonus expense from Ibbotson.  The increase in operating expense also reflects $1.6 million of amortization expense for intangible assets acquired with Ibbotson and $1.1 million in outsourced product implementation expense for the Advice by Ibbotson® service. Morningstar recognizes these product implementation expenses as they are incurred; however, recognition of the associated revenue does not begin until client testing is complete.

The company’s operating margin was 22.9% in the second quarter of 2006, compared with 23.4% in the same period in 2005. The combined impact of three factors—the adjustment to bring year-to-date bonus expense in line with the updated full-year estimate, the impact of the Advice by Ibbotson product implementation expense, and the amortization of intangible assets—reduced the operating margin by 4.5 percentage points in the quarter. In the first six months of 2006, operating margin was 25.1%, compared with 18.3% in the first six months of 2005.  A $2.8 million decrease in stock-based compensation expense had a positive impact on margins for the year-to-date period.   

Income Taxes: Income tax expense in the quarter increased $3.0 million, or 66%, compared with the prior- year period, causing net income growth to lag operating income growth. The increase in income tax expense in the second quarter of 2006 was due to additional income tax expense outside the United States. In addition, the second quarter of 2005 included a one-time deferred tax benefit for research and development, which reduced income tax expense in that quarter.


Free Cash Flow:  Morningstar generated free cash flow of $28.3 million in the second quarter of 2006, reflecting cash provided by operating activities of $29.5 million and capital expenditures of $1.2 million. Free cash flow increased by $15.7 million in the quarter, partly because of a $6.6 million reduction in income tax payments reflected in cash provided by operating activities. The $6.6 million reduction includes approximately $8 million in cash tax benefits from the Ibbotson acquisition, partially offset by a $1.4 million increase in cash tax payments from higher taxable income. A decrease in working capital, excluding cash, and an increase in net income also contributed to the increase in free cash flow.

In the first six months of 2006, Morningstar generated free cash flow of $37.4 million, reflecting cash provided by operating activities of $39.4 million and capital expenditures of $2.0 million. Free cash flow in the first six months of 2006 increased $28.1 million compared with the prior-year period, reflecting a $27.8 million increase in cash provided by operating activities and a $0.3 million decrease in capital expenditures.  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 June 30, 2006, Morningstar had cash, cash equivalents, and investments of $121.4 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, partially offset by cash from operations and proceeds from stock option exercises.

Business Segment Performance
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 $19.4 million in the second quarter of 2006, a 24% increase from $15.6 million in the second quarter of 2005. Morningstar.com and Equity Research drove most of the revenue increase.   
• Operating income was $6.2 million in the second quarter of 2006, a 37% increase from $4.6 million in the prior-year period. 
• Operating margin was 32.1% in the second quarter of 2006, compared with 29.1% in the second quarter of 2005.

Advisor Segment:  The largest products in this segment based on revenue are Morningstar® Advisor WorkstationSM, Morningstar® Principia®, and Morningstar® Managed PortfoliosSM.
• Revenue was $24.3 million in the second quarter of 2006, a 30% increase from $18.8 million in the same period in 2005. Advisor Workstation contributed the majority of the revenue increase.  
• Operating income was $6.4 million in the second quarter of 2006, an increase of 51% compared with $4.2 million in the second quarter of 2005.  
• Operating margin was 26.3% in the second quarter of 2006, compared with 22.6% in the second quarter of 2005. 

Institutional Segment:  The largest 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 $34.3 million in the second quarter of 2006, a 49% increase from $23.0 million in the second quarter of 2005. Investment Consulting, Encorr, and Licensed Data drove the majority of the revenue increase.
• Operating income was $7.3 million in the second quarter of 2006, an increase of 49% from $4.9 million in the same period in 2005. 
• Operating margin was 21.3% in the second quarter of 2006, compared with 21.4% in the prior-year period.

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 13 countries and minority ownership positions in companies based in three 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 considered as non-GAAP by the Securities and Exchange Commission:  free cash flow, operating income before stock-based compensation expense, operating margin before stock-based compensation expense, and revenue growth adjusted for the Ibbotson acquisition and the impact of foreign currency (organic revenue growth).

Morningstar presents free cash flow solely as supplemental disclosure to help 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. 

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 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. 

Morningstar presents revenue growth rates adjusted for the Ibbotson acquisition and the impact of foreign currency (organic revenue growth) because the company believes this non-GAAP measure helps investors better compare period-to-period results. For more information on organic revenue growth, please see the reconciliation provided in the accompanying financial tables.

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