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Margaret Kirch Cohenmargaret.cohen@morningstar.com
Morningstar, Inc. Reports Third-Quarter 2007 Financial Results
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CHICAGO, Nov. 1, 2007—Morningstar, Inc. (NASDAQ: MORN), a leading provider of independent investment research, today announced its third-quarter 2007 financial results. The company reported consolidated revenue of $111.9 million in the third quarter of 2007, a 37% increase from revenue of $81.8 million in the third quarter of 2006. Morningstar’s third-quarter results included $10.2 million in revenue from acquisitions completed during the previous 12 months. Consolidated operating income was $31.4 million in the third quarter of 2007, an increase of 53%, compared with $20.5 million in the third quarter of 2006. Morningstar’s net income was $19.9 million in the third quarter of 2007, or 41 cents per diluted share, compared with $13.5 million, or 29 cents per diluted share, in the third quarter of 2006.

Morningstar’s third-quarter results include revenue from previous acquisitions, including the mutual fund data business acquired from Standard & Poor’s on March 16, 2007. Excluding acquisitions and the impact of foreign currency translations, Morningstar’s revenue increased approximately 23% in the third quarter of 2007. Foreign currency translations had a positive impact of $0.9 million in the quarter. Revenue excluding acquisitions and foreign currency translations (organic revenue) is a non-GAAP measure; the accompanying financial tables contain a reconciliation to consolidated revenue.

In the first nine months of 2007, revenue increased $88.9 million, or 39%, to $317.0 million, compared with $228.1 million in the same period a year ago. Revenue for the first nine months of the year included $35.4 million from acquisitions. Consolidated operating income increased 47% to $83.9 million in the first nine months of 2007, compared with $57.2 million in the prior-year period. Net income was $53.9 million, or $1.13 per diluted share, in the first nine months of 2007, compared with $38.2 million, or 82 cents per diluted share, in the same period in 2006.
Joe Mansueto, chairman and chief executive officer of Morningstar, said, “We’re pleased with our results this quarter. Our key products continue to perform well, with Investment Consulting contributing the most to revenue growth. Assets under advisement for Investment Consulting rose to $91.4 billion, up from $47.6 billion a year ago. Morningstar Advisor Workstation was the second largest contributor to revenue growth during the quarter, followed by Licensed Data, Morningstar Direct, and Morningstar.com.”

Mansueto added, “Our operations outside the United States grew substantially. We’re now much more diversified geographically, with more than 20% of our revenue base coming from outside the United States. It’s also worth noting that our third-quarter operating margin grew 3 percentage points year over year, reflecting the fundamental health of our business and our ability to leverage our core assets of proprietary investment research and data. Continued growth in our Institutional segment, as well as contributions from some acquired operations, helped drive our operating margin increase.”

Key Business Drivers
Revenue: In the third quarter of 2007, revenue in the Institutional segment grew 58% compared with the third quarter of 2006; 21 percentage points of this increase came from acquisitions. Revenue in the Advisor segment rose 20%, of which 6 percentage points came from acquisitions. Individual segment revenue rose 16%, with 3 percentage points of this increase coming from acquisitions.

Revenue from international operations was $24.9 million in the third quarter of 2007, an increase of 102% from the same period a year ago. International revenue included $8.6 million from acquisitions, primarily from Standard & Poor’s fund data business. Excluding the impact of acquisitions and foreign currency translations, international revenue grew approximately 25% in the third quarter of 2007, compared with the prior-year period. For the first nine months of 2007, international revenue rose 110%, with the majority of the increase coming from acquisitions. International revenue excluding acquisitions and foreign currency translations is a non-GAAP measure; the accompanying financial tables contain a reconciliation to international revenue.

Operating Income: Consolidated operating income was $31.4 million in the third quarter of 2007, a 53% increase from the same period in 2006. Operating expense rose $19.1 million, or 31%, in the third quarter of 2007. Because of the timing of acquisitions made during the past 12 months, Morningstar had additional expenses in the third quarter of 2007 that did not exist in the same period in 2006. These expenses include amortization of intangible assets related to acquisitions, which contributed an additional $1.5 million to operating expense in the quarter.
Compensation-related expense, excluding bonuses, increased $8.3 million, with the majority of the increase coming from additional headcount. Bonus expense increased $3.7 million in the quarter. Another key contributor to the higher operating expense was an increase in general and administrative expense related to temporary transition costs and professional fees associated with the fund data operations acquired from Standard & Poor’s, primarily in Europe. The company also recorded $0.9 million in expense related to the settlement of litigation in Australia. Worldwide headcount grew to approximately 1,680 employees as of Sept. 30, 2007, compared with 1,400 as of Sept. 30, 2006. This growth primarily reflects employees from acquisitions, hiring in the United States, and continued hiring in the company’s development center in China.

The company’s operating margin was 28.1% in the third quarter of 2007, compared with 25.1% in the same period in 2006. In the first nine months of 2007, operating margin was 26.5%, compared with 25.1% in the first nine months of 2006.

Free Cash Flow: Morningstar generated free cash flow of $24.9 million in the third quarter of 2007, reflecting cash provided by operating activities of $28.4 million and capital expenditures of $3.5 million. Despite the increase in net income, cash flow from operations decreased because of a $5.7 million change in deferred revenue related to product renewals. Morningstar frequently invoices sales and collects cash in advance of providing services or fulfilling client subscriptions. Deferred revenue declined relative to second-quarter 2007 levels because of the timing of subscriptions and license renewals in the third quarter. Morningstar experienced a similar trend in the third quarter of 2006, but to a lesser degree. Significantly higher income tax payments also offset the positive cash flow impact of the increase in net income. In 2006, cash flow from operations reflected a $13.0 million cash tax benefit from the Ibbotson acquisition, which resulted in lower tax payments. Because this was a one-time benefit in 2006, income tax payments increased in 2007. The payment related to the Australian litigation also reduced cash flow from operations in the third quarter of 2007.

Capital expenditures in the quarter increased $2.6 million mainly because of spending for office space build-outs in several locations. The company expects capital expenditures to be significantly higher in 2008 than in previous years primarily because of spending for its new corporate headquarters in Chicago.

In the first nine months of 2007, Morningstar generated free cash flow of $63.5 million, reflecting cash provided by operating activities of $72.9 million and capital expenditures of $9.4 million. Cash flow from operations in the first nine months of 2007 increased $3.9 million, lagging the increase in net income because of higher payments for bonuses, income taxes, and the Australian litigation. Bonuses paid in the first nine months of 2007 were $12.3 million higher than in the prior-year period because of strong company performance and incremental bonuses for businesses acquired during 2006. Income tax payments were $18.0 million higher than in the prior-year period. In 2006, cash flow from operations reflected a $13.0 million cash tax benefit related to the Ibbotson acquisition. 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, 2007, Morningstar had cash, cash equivalents, and investments of $193.1 million, compared with $163.8 million as of Dec. 31, 2006.

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 $23.7 million in the third quarter of 2007, a 16% increase from $20.4 million in the third quarter of 2006.
  • Acquisitions contributed revenue of $0.7 million to the Individual segment in the third quarter, all of which came from Aspect Huntley.
  • Morningstar.com, including Premium Membership and Internet advertising sales, was the main contributor to the increase in organic revenue. Newsletters and Equity Research also contributed to the revenue growth.
  • During the quarter, the company launched a new section on Morningstar.com that features equity option data and information.
  • Operating income was $6.2 million in the third quarter of 2007, a 12% increase from $5.5 million in the prior-year period. Operating expense increased in 2007, primarily because of the Aspect Huntley acquisition and higher compensation expense.
  • Operating margin was 26.1% in the third quarter of 2007, compared with 27.0% in the third quarter of 2006.
    The margin decline was mainly due to the Aspect Huntley acquisition.

    Advisor Segment: The largest products in this segment based on revenue are Morningstar® Advisor WorkstationSM, Morningstar® Principia®, and Morningstar® Managed PortfoliosSM.
  • Revenue was $29.3 million in the third quarter of 2007, a 20% increase from $24.4 million in the same period in 2006. In the third quarter of 2006, Advisor segment results included one-time revenue of $1.3 million related to eliminating a redundant license following the merger of two clients.
  • Acquisitions contributed revenue of $1.4 million to the Advisor segment in the third quarter, primarily from the acquisition of Standard & Poor’s fund data business.
  • Morningstar Advisor Workstation drove most of the growth in organic revenue. Total licenses for Morningstar Advisor Workstation in the United States increased to 173,877 as of Sept. 30, 2007, compared with 121,179 in the prior-year period. Part of this growth reflects changes in the scope of some contracts. In 2007, a few clients who previously held tools-only contracts converted their agreements to full-site licenses. For full-site licenses, Morningstar includes all affiliated advisors who have access to the site in the total license count. By contrast, for tools-only contracts, Morningstar includes a smaller number of advisors in the total based on actual usage.
  • Principia subscriptions grew to 49,303 as of Sept. 30, 2007, compared with 48,944 in the prior-year period, in large part because of the introduction of two new modules, Presentations and Education and Asset Allocation.
  • During the quarter, the company launched Morningstar Site Builder, a software package that investment companies can customize to integrate Morningstar tools and reports into their advisor Web sites. Morningstar also introduced a local version of Advisor Workstation Office Edition in the United Kingdom.
  • Operating income was $8.7 million in the third quarter of 2007, an increase of 12% compared with $7.7 million in the third quarter of 2006.
  • Operating margin was 29.5% in the third quarter of 2007, compared with 31.6% in the third quarter of 2006. This segment’s operating margin was 3.8 percentage points higher in the third quarter of 2006 because of the $1.3 million in one-time revenue related to eliminating a redundant license following the merger of two clients.

Institutional Segment: The largest products and services in this segment based on revenue are Investment Consulting, Licensed DataSM, Retirement Advice (including Advice by Ibbotson® and Morningstar® Retirement ManagerSM ), the institutional Workstation product acquired from Standard & Poor’s, Licensed Tools and Content, and Morningstar DirectSM.

  • Revenue was $60.8 million in the third quarter of 2007, a 58% increase from $38.6 million in the third quarter of 2006.
  • Acquisitions contributed revenue of $8.1 million to the Institutional segment in the third quarter, primarily from the acquisition of Standard & Poor’s fund data business.
  • Investment Consulting was the largest contributor to revenue growth. Licensed Data and Morningstar Direct also made meaningful contributions to organic revenue growth.
  • Operating income was $20.7 million in the third quarter of 2007, versus $9.7 million in the same period in 2006. Operating expense grew in this segment, but at a much lower rate than the revenue increase.
  • Operating margin was 34.0% in the third quarter of 2007, compared with 25.0% in the prior-year period. The majority of the increase was driven by growth in higher-margin services, such as Investment Consulting, as well as the fund data business acquired from Standard & Poor’s.
    Important Note: Beginning in early 2008, when Morningstar releases its year-end 2007 financial results, the company will issue its press release after the market closes as opposed to before the market opens. Morningstar is making this change to give investors more time to review its results before the market opens.

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 260,000 investment offerings, including stocks, mutual funds, and similar vehicles. The company has operations in 18 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, 2006. 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 U.S. Generally Accepted Accounting Principles (GAAP), Morningstar uses the following measures considered as non-GAAP by the Securities and Exchange Commission: free cash flow, consolidated revenue excluding acquisitions and foreign currency translations (organic revenue), and international revenue excluding acquisitions and foreign currency translations. These non-GAAP measures may not be comparable to similarly titled measures reported by other companies.

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). 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 consolidated revenue excluding acquisitions and foreign currency translations (organic revenue) and international revenue excluding acquisitions and foreign currency translations because the company believes these non-GAAP measures help investors better compare period-to-period results. For more information, please see the reconciliation provided in the accompanying financial tables.
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© 2007 Morningstar, Inc. All rights reserved.

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